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Munich Reinsurance America, Inc.Basics of CAT Modeling WebinargJune 4, 2009

Agenda

IntroductionCarl HeddeCarl Hedde

Tropical Cyclone BasicsM k BMark Bove

Basics of Catastrophe ModelingMark Bove

Hurricanes, Society, and Insurance, y,Carl Hedde

1

Question and Answer Process

You may submit a question at any time during the session.

Find the Chat function in the right hand side of the screen.

Send questions to “Host”.

Tropical Cyclone Basics

What is a Tropical Cyclone?Tropical Cyclone Basics

A nonfrontal low-pressure system that develops over tropical or subtropical waters. Has organized convection (i.e., thunderstorm activity) and definite cyclonic (counterclockwise in northern hemisphere) surface wind circulation. Derives most of its energy from the release of latent heat.

Sustained winds below 39 mph and closed a surface circulation. Tropical

Naming conventions

p(Storm is given a number)

pDepression

Tropical Sustained winds between 39 - 73 mph.(S i i )Storm (Storm is given a name)

Sustained winds above 73 mph. Hurricane, Typhoon, ypCyclone

4

Saffir-Simpson Hurricane Wind ScaleTropical Cyclone Basics

Category Winds (mph, 1 minute average)

Description Example U.S. Storms

1 74-95 Damaging winds expected Lili (2002)

2 96-110 Widespread damage expected Gustav (2008)

3 111-130 Extensive damage expected Ivan (2004)3 111-130 Extensive damage expected Ivan (2004)

4 131-155 Devastating damage expected Charley (2004)

5 >155 Catastrophic damage expected Andrew (1992)New scale is experimental in 2009, central pressure and surge estimates have been removed due to wide variability in pressure and surge associated with a given wind speed.Due to uncertainty in wind measurements, tropical cyclone winds reported operationally in 5 mph increments.

fMaximum sustained wind given for a storm usually only covers a very small area.The force of wind on structures increases as the cube of the wind speed, so damage potential does not increase linearly with wind speeds.Category 3, 4, and 5 hurricanes are considered “major” hurricanes, which account for about 20% f ll U S l df ll b b 80% f ll i d l d i l l20% of all U.S. landfalls, but about 80% of all insured losses due to tropical cyclones.

5

Tropical Cyclone Structure:Nature’s Heat Engine

Tropical Cyclone Basics

Nature s Heat Engine

Outflow (“Exhaust”)

Energy Release(“Cylinders”)

O (“F l”)Ocean (“Fuel”)

Source: NOAA 6

Tropical Cyclone Development RequirementsTropical Cyclone Basics

Water temperatures of ~80 °F to a depth of at least 150 feet.

Be at least 300 miles away from the equator.

Light upper atmospheric winds.

Moist, unstable atmosphere at low and mid-level altitudes.

A weak pre-existing weather disturbance.

7

ºFTropical Cyclone Basics

77º

86ºWind shear common

68º

77º

68

59º

50º

59

Hurricane development not possible near Equator

50

41ºp p q

32ºData Source: U.S. Naval Research Labs, Stennis, MS.

Atlantic Hurricane Tracks, 1970 - 2008Tropical Cyclone Basics

Map: NOAA Coastal Services Center 9

Causes of Tropical Cyclone Lysis Tropical Cyclone Basics

Moving over colder water.

Moving over land / interaction with nearby land.

Wind shear.

Dry air intrusion / Saharan dust layers.

Interaction with or absorption into an extratropical cyclone.Interaction with or absorption into an extratropical cyclone.

“Extratropical transition”

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Extratropical TransitionTropical Cyclone Basics

Process of tropical cyclone becoming an extratropical (frontal) cyclone. Usually induced when hurricanes interact with colder drier air jet streams orUsually induced when hurricanes interact with colder, drier air, jet streams, or extratropical weather systems, such as a cold front.

Floyd as Tropical Low Floyd as Transitioning Low

Source: NOAA 11

Primary Hurricane Hazards: WindTropical Cyclone Basics

Damage due to force of wind (direct)Damage due to impact of wind-driven objects (indirect)Damage due to impact of wind driven objects (indirect)

Photos: Munich Reinsurance America

Charley Wilma

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Primary Hurricane Hazards: Storm SurgeTropical Cyclone Basics

Onshore rush of sea or lake water caused by the high winds associated with a landfalling cyclone and secondarily by the low pressure of the storm.g y y y pTypically accompanied with extensive wave damage and erosion along immediate coastline.

Photo: Munich Reinsurance America

Katrina

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Basics of Catastrophe Modeling


Catastrophe models have many different functions

Develop catastrophe pricing loads by postal code or rating territory.

Track exposure levels in key catastrophe regions.

Calculate the effects of deductibles and other risk mitigation techniques.

Quantify potential of catastrophic loss by peril.

Evaluate the impact and cost of reinsurance protection.

Estimate potential losses of real world eventsEstimate potential losses of real world events.

Satisfy regulatory requirements.

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Catastrophe models utilize the following risk-specific information

Address Policy Deductible

Location specific information Financial information

Building Construction and Occupancy

Number of stories

Policy and Coverage Limits

Value of Location

Year of Construction

16


There are four basic components to all catastrophe models, regardless of the peril being modeled.

St h ti E t S tStochastic Event Set

Intensity CalculationIntensity Calculation

Damage EstimationDamage Estimation

Loss Evaluation

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Stochastic Event Set

A set of discrete events covering all the important combinations of location size and other pertinent characteristics of the peril inlocation, size, and other pertinent characteristics of the peril in question, as well as the (annual) probability of each event.

Account for all locations that are impacted by peril of interest.

Have a sufficient number of events to A Stochastic Event Set should:

cover all possible sizes and intensities that are possible in a given location.

Consider the probability of a given event occurring.

Have enough events to produce statistically stable loss results.

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Intensity Calculation

A set of rules to calculate the intensity of each event at every site of interest (individual location insurance portfolio etc )interest (individual location, insurance portfolio, etc.).

Be based on established physics of the hazard being modeled.

Intensity Calculations should:

Should be calculated at every location of interest.

Should consider environmentalShould consider environmental influences at or around site of interest.

To calculate event intensities at each location of interest, the model requires Geocoding and the relevant Geospatial Hazard Databases for

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requires Geocoding and the relevant Geospatial Hazard Databases for the peril being modeled. Both of these tools are included in the model.



Computer program that transforms location information contained in exposure

Geocoding

Computer program that transforms location information contained in exposure data (building number, street, city, state, and postal code) into coordinates (usually latitude and longitude) that the risk modeling software can process.

The most desirable resolution depends on the peril usually the more detailed theThe most desirable resolution depends on the peril, usually the more detailed the better.

555 College Road East

Princeton, NJ 08543

= 40.351 ºN, 74.593 ºW

Map: Munich Reinsurance America 20



Geospatial Hazard Databases

Databases containing information on the local environmental and/or physical factors that can influence an event’s intensity at the site.

The relevant information depends h il i h i lon the peril; with respect to tropical

cyclones: topography and surface roughness.

Source: USGS

21

Damage EstimationBasics of Catastrophe Modeling

Computational models to estimate the damage level of each structure, given its vulnerability to the particular peril and the event’s intensity at the site.y y

Consider several types of construction and building occupancy (“primary modifiers”).

Consider other construction techniques that

Damage Estimation

Consider other construction techniques that either increase or decrease vulnerability to the peril in question (i.e. “secondary modifiers”).

Consider the initial quality of construction, including the adoption and enforcement of g

should:g p

building codes, as well as the age and the maintenance of the building.

Have different damage/vulnerability functions for buildings (structural and nonstructural elements), g ( ),contents, and time element.

Use a consistent measure to correlate event intensity with building damage.

Account for so called secondary hazards such

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Account for so-called secondary hazards, such as storm surge and demand surge.

Loss EvaluationBasics of Catastrophe Modeling

Evaluate insured losses, given the damage level & values, as well as the applicable insurance and reinsurance structures, such as deductibles, limits,

Determine how building damage translates into insurance loss.

pp , , ,attachment points, treaty cessions, etc.

L E l ti

Determine whether or how to account for:

Demand surgeLoss Evaluation should:

– Demand surge

– Price gouging

– Inflated claims

– Aggressive construction contractors

Questionable claims settlement– Questionable claims settlement

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Part of model

StochasticEvent Set

IntensityCalculation

GeocodingEngine

Geospatial Hazard

Database

DamageEstimationEstimation

LossEvaluation

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Part of modelProvided by user

StochasticEvent Set

IntensityCalculation

GeocodingEngine

Geospatial Hazard

DatabaseExposure

Data

DamageEstimation

Data

Estimation

Loss

InsuranceStructure

Evaluation

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1. Event Definition 2. Intensity Calculation

tens

ity a

t Site

int

LocationSizeType

Eve

nt In

Source-to-Site Distance

dist

yp(Probability)

4. Loss Evaluation 3. Damage Estimation

orsity Deductible

Dam

age

Fact

o

int

mean DF

The standard deviationis usually estimated as a function of the mean

Prob

abilit

y D

ens

Ground-Up Loss= DF x Repl. Value

Limit

Repl ValueEvent Intensity at Site

intP

Ground-Up LossRepl. Value

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Involves evaluatingthe sum of correlated

Creating Event Loss DistributionsC bi (b ildi t t the sum of correlated

random variables andapplying the appropriatedeductibles and limits

Combine coverages (building, contents, time element) to arrive at a site (account) loss distribution for each

t deductibles and limits.event.Combine sites to yield a policy loss distribution for each event.C bi li i d f li

By evaluating the

Combine policies to produce a portfolio loss distribution for each event.

Creating Annual Loss Distributions By evaluating the probability that the loss from any one (two, three etc.) event(s) can exceed

i th h ld

Creating Annual Loss DistributionsCombine all event loss distributions to arrive at an annualized probability distribution any given threshold.

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distribution.


Losses can be produced for a variety of financial perspectives.

The output of the catastrophe model contains the losses by event by financial perspective.

Ground Up Loss (Loss before policy limits/deductibles)

Gross LossGross Loss(Loss after application of limits and deductibles)

Treaty Loss(Loss to individual treaties)Financial perspectives

Net Loss (Loss after limits, deductibles, and treaties)

Reinsurance Loss

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(Loss suffered by the reinsurer)


Exceedance Probability Curveee

danc

eity

of E

xce

l Pro

babi

liA

nnua

1/N

Loss ($) N-yr Loss

29


Example of output from a catastrophe model

Event ID Perspective Loss Probability

1 Gross 5,000,000 0.6%

2 Gross 20,000,000 0.3%

3 Gross 10 000 000 0 1%3 Gross 10,000,000 0.1%

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When assessing catastrophe risk, the two main measures of loss are:

Return period losses are a measure of ultimate risk, and are often used in risk management and accumulation control decisions

Return Period Losses accumulation control decisions. Losses

Average Average Annual Loss is a measure of expected Annual Loss

loss, and provides the starting point for pricing the catastrophe component of treaties.

31

Return Period LossesBasics of Catastrophe Modeling

Potential catastrophe losses are often expressed in terms of an d b bilit Th t i d i th i f thexceedence probability. The return period is the inverse of the

exceedence probability (ex: 1% EP = 1 in 100 year loss). This is often referred to as a PML (Probable Maximum Loss)

This represents the loss level that we would expect to surpass, on average, once every “n” years.

The larger the return period, the more conservative the loss estimate.

This method of loss estimation does not attempt to quantify the potential loss estimate for the nth year.

Return Period Losses are depicted graphically with the EP curve.

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Construction of EP Curve

Step 1: Sort the events in descending order of loss


2 Gross 20,000,000 0.3%

1 Gross 10,000,000 0.1%, ,

3 Gross 5,000,000 0.6%

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Step 2: Aggregate the probabilities

Event ID Perspective Loss ProbabilityAccumulated Probability

2 Gross 20,000,000 0.3% 0.3%

1 Gross 10,000,000 0.1% 0.4%1 Gross 10,000,000 0.1% 0.4%

3 Gross 5,000,000 0.6% 1.0%

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Step 3: Graph the losses and accumulated probabilities for each event

35



EP Curves and Return Periods

ID Persp Loss ProbabilityAccumulated Return

The Return Period is 1 / Accumulated Probability

ID Persp. Loss ProbabilityProbability Period

2 Gross 20,000,000 0.3% 0.3% 333

1 Gross 10,000,000 0.1% 0.4% 250

3 Gross 5,000,000 0.6% 1.0% 100

In this example, the 1/250 year is $10M.249 years out of 250 losses are expected to be less than 10M

, ,

249 years out of 250 losses are expected to be less than 10M.

36

Average Annual Loss (AAL)Basics of Catastrophe Modeling

Also referred to as expected loss or pure premium.


Calculated as sum (Loss * Event Probability) for all events.


2 Gross 20,000,000 0.3%

1 Gross 10,000,000 0.1%

3 Gross 5,000,000 0.6%

AAL = (20M * .3%) + (10M * .1%) + (5M * .6%) = 150K

, ,

37

Average Annual Loss (AAL)Basics of Catastrophe Modeling

AAL of 150K represents the amount of loss expected in a given year.

This measure is more useful for pricing than risk management.

For risk management purposes, the 150K “average” has little significance.

This company has 0 losses 99 years out of 100 and the 100th year suffers losses of at least 5M.

Graphically, the AAL represents the area under the EP curve.

38

Hurricanes, Society, & Insurance

Photo: Munich Reinsurance America

Coastal Exposures: A Rapidly Growing RiskHurricanes, Society, & Insurance

Historical Losses due to natural catastrophes in the United States are i i d ti llincreasing dramatically.

Insured losses are about nine times greater during the past ten years than in the 1980s.the 1980s.

Most of the increase of losses is due to coastal exposures vulnerable to tropical cyclones.

– Population – The U.S. coastal population grew by about 40 million from 1980 – 2008 (U.S. Census Bureau).

– Values – Property values along the coast are increasing.

– Building Units – The number of building units are increasing.

– Climate Change – Potential of increased storm severity and/or frequency.

41

Economic and Insured Property Losses Due to Significant United States Natural Catastrophes1950 2008 (All values 2008 Dollars)


1950 - 2008 (All values 2008 Dollars)

“Significant” is defined as at least $1 billion in economic losses or 50 fatalities are

Source: Munich Re Topics Geo, 2008 U.S. Edition

Significant is defined as at least $1 billion in economic losses or 50 fatalities are directly attributed to the event.

42

Insured U.S. Tropical Cyclone Losses1980 - 2008


1980 2008

The current 5-year average (2004-2008) insured tropical cyclone loss is $28.3 bn.

Source: Property Claims Service, MR NatCatSERVICE, NFIP© 2009 Munich Re Group 43

Top 10 U.S. Property Natural Catastrophe Losses,Original Insured Dollar Loss


$40.5

$45.0

Original Insured Dollar Loss

$30 0

$35.0

$40.0

$20.0

$25.0

$30.0

$7.1 $7.5

$10.3 $11.5

$12.5

$15.5

$10.0

$15.0

$4.2 $4.6 $5.3 $

$0.0

$5.0

Hurricane Hugo (1989)

Hurricane F (2004)

Hurricane Rita (2005)

Hurricane Ivan (2004)

Hurricane Ch l (2004)

Hurricane Wil (2005)

Hurricane Ike (2008)

Northridge E th k

Hurricane A d (1992)

Hurricane K t i (2005)(1989) Frances (2004) (2005) (2004) Charley (2004) Wilma (2005) (2008) Earthquake

(1994)Andrew (1992) Katrina (2005)

Data Source: PCS. Losses in original dollar amounts. Does not include offshore losses, aviation losses or losses to the NFIP. 44

Estimated Top 10 U.S. Natural Catastrophe Losses1900 – 2006, Insured Losses As If Occurred Today


, y

$78 0$80.0

$90.0

$78.0

$60 0

$70.0

$80.0

$36.0

$41.0 $42.0

$49.0 $53.0

$40.0

$50.0

$60.0

$27.0 $28.0 $31.0

$36.0

$20.0

$30.0

$0.0

$10.0

Galveston H i (191 )

Southwest Fl id (1944)

Great New E l d

Ft. Lauderdale H i (194 )

Hurricane K i (200 )

Hurricane A d (1992)

Great Ok h b

Great Galveston H i (1900)

San Francisco E h k

Great Miami H i (1926)

Data Sources: RMS, PCS. Modeled Losses to property, contents, and BI for personal, commercial, mobile home and auto lines.Includes Storm Surge, Demand Surge, and large loss amplification. 45

Hurricane (1915) Florida (1944) England Hurricane (1938)

Hurricane (1947) Katrina (2005) Andrew (1992) Okeechobee Hurricane (1928)

Hurricane (1900) Earthquake (1906)

Hurricane (1926)

U.S. Coastal Population Change by County, 1980 - 2003


y y,

42% of the population in Atlantic coastal states lives in coastal counties. This is equal to 19% of the U.S. population.

46Image: NOAA

Percentage of State Population in Atlantic Coast Counties


Coast Cou t es

Total Coastal Population:

Map: Munich Re America. Data: U.S. Census Bureau

p56.4 million

47

Breakdown of U.S. Coastal Population by RegionHurricanes, Society, & Insurance

47%

17%

14%

22%

TX – AL: 7.9 million

FL: 12.3 million

GA – DE: 9.4 million

Map: Munich Re America. Data: U.S. Census Bureau

NJ – ME: 26.9 million

48

Total Value of Coastal Exposures(2004 Dollars, Billions)


( 00 o a s, o s)

Source: Insurance Information Institute 49

Impact of Climate ChangeHurricanes, Society, & Insurance

Increased sea surface temperature may lead to increased hurricane severity and frequency.

50

Economic Reasons for Excessive Coastal Property Exposures


Property Owners Local Zoning & Permitting Authorities

Developers

p y p

Low cost of living; low real estate prices & rapid appreciation; no state income tax in some locales;

Residential construction creates jobs; attracts wealth; increases tax receipts, stimulates

Coastal development is a high-margin business.Financial interest and risk reduced to zero afterincome tax in some locales;

low property tax; rapid job growth.Government-run insurers (e.g., CPIC, NFIP) provide

receipts, stimulates commercial construction & permanent jobs; develops infrastructure.Increases local

risk reduced to zero after sale.

(e.g., CPIC, NFIP) provide implicit subsidies by selling insurance at below-market prices with few underwriting restrictions.

c eases ocarepresentation in state legislature & political influence.Property and infrastructure es c o s

Government aid; tax deductions; litigation recovery for uninsured losses.

p ydamage costs shifted to others (state and federal taxpayers, policyholders in unaffected areas, and non-

No fear of death and injury.,

property policyholders.

51

Example: Impact of Coastal Property on Insured Losses


Residental Home in Florida

Concrete Block Exterior Walls

Wood Frame Gable Roof

Wind-Resistant Shingles

Insured Values

$500,000 Building

$250,000 Contents

$150,000 Loss of Use

Photo: Munich Re America 52



Modified Home Parameters

Location

On Coast

10 Miles Inland10 Miles Inland

Roof Anchors

Toe Nailing

Metal Anchors

Construction Date

1980

2005

Mi iMiami

53



Expected Average Annual Loss Due to Wind

Coast Inland

B ilt i 2005 M t l R f A h $3 304 $699Built in 2005, Metal Roof Anchors $3,304 $699

Built in 2005, Toe Nailing $4,613 $1,078

Built in 1980, Metal Roof Anchors $11,306 $3,862

Built in 1980, Toe Nailing $17,028 $6,259, g

54



Loss Due to Wind, 1% Annual Probability of Exceedance(100-Year Return Period)

Coast Inland

Built in 2005 Metal Roof Anchors $67 180 $14 364Built in 2005, Metal Roof Anchors $67,180 $14,364

Built in 2005, Toe Nailing $102,095 $21,081

Built in 1980, Metal Roof Anchors $276,411 $104,760

Built in 1980, Toe Nailing $465 435 $180 069Built in 1980, Toe Nailing $465,435 $180,069

55

Example: Controlling and Managing RiskHurricanes, Society, & Insurance

How do expected losses change as one moves in from the coast?

Eleven locations at the same latitude at 1-mile increments from coast to 10 miles inland.

Construction types

– 2005 - Toe Nailing

– 2005 - Metal Anchor

– 1980 - Toe Nailing

– 1980 - Metal Anchor

Mi i

56

Miami

Change in Expected Annual Loss by Construction:Coast to 10 miles Inland, Wind-Only


, ys

($)

nd-U

p Lo

ssG

roun

Distance from Coast (Miles)

57

Successful Tools for Controlling and Managing Coastal Risk


g g

Improved land use planning

B ildi d i t & t i t d f tBuilding code improvements & stringent code enforcement.

Improved construction techniques.

Incentivize mitigation measures.

Actuarially sound, risk-based insurance rates.

Remove impediments that impact capital flows dedicated to risk financing.

Free market mechanics.

58

Unsuccessful Tools for Controlling And Managing Coastal Risk


g g

Actuarially unsound insurance rates

G fGovernment imposed restraints negatively impacts the availability of insurance.

Retroactive interpretation/re-writing of insurance contractsRetroactive interpretation/re-writing of insurance contracts.

Weak building codes and poor code enforcement.

Poor land use planningPoor land use planning.

59

Building Wind Vulnerabilities: Poor PerformersHurricanes, Society, & Insurance

Large, unprotected openings

Flat roofs or gable roofs

Large overhangsLarge overhangs

Irregular shapes (e.g., dormers)

A d d/ t t l ti bAged wood/structural timber

High rise buildings

60

Large, Unprotected OpeningsHurricanes, Society, & Insurance

Wilma

61Photo: Munich Re America

Gable Roofs & WallsHurricanes, Society, & Insurance

Charley

62Photos: Munich Re America

Flat RoofsHurricanes, Society, & Insurance

Ivan


Strip MallsHurricanes, Society, & Insurance

Large, unprotected openings + flat roofs + large overhangs

Charley

64Photos: Munich Re America

Roof IrregularitiesHurricanes, Society, & Insurance

K t iKatrina


Building Wind Vulnerabilities: Good PerformersHurricanes, Society, & Insurance

Newer, stricter building codes appeared to be effective.

Monolithic concrete boxes perform very well.

Mitigation measures such as hurricane shutters and seawalls work!Mitigation measures, such as hurricane shutters and seawalls work!

66

An Undamaged New HouseHurricanes, Society, & Insurance

CharleyCharley


Concrete Boxes Perform WellHurricanes, Society, & Insurance

Jeanne


Seawalls Protect Against Surge and ErosionHurricanes, Society, & Insurance

69

Jeanne

Photo: Munich Re America

Institute for Business and Home Safety (IBHS) Fortified Homes, Bolivar Peninsula, Texas


Ike

Photo: Munich Re America

2009 Atlantic Hurricane Season ForecastsHurricanes, Society, & Insurance

Named Storms Hurricanes Major Hurricanes

NOAA 9 14 4 7 1 3NOAA 9-14 4-7 1-3

Colorado State University

12 6 2

Cit College of 15 8 4City College of London

15 8 4

Climatology 11 6 2

71

Thank you for your time and interest!

© Copyright 2009 Munich Reinsurance America, Inc. All rights reserved. The Munich Re America name is a mark owned by Munich Reinsurance America, Inc.

The material in this presentation is provided for your information only, and is not permitted to be further distributed without the express written permission of Munich Reinsurance America. This material is not intended to be legal, underwriting, financial or any other type of professional advice Examples given are for illustrative purposes only Each reader shouldfinancial, or any other type of professional advice. Examples given are for illustrative purposes only. Each reader should consult an attorney and other appropriate advisors to determine the applicability of any particular contract language to the reader's specific circumstances.

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