Appendix VII

Comments from the Bond Market Association

See comment 2.

party's is required to consolidate. We believe that this new paradigm will result in numerous false positives, requiring consolidation by enterprises that in fact do not exercise a controlling financial interest. We strongly oppose this result and, consequently, also oppose the new paradigm.

The comment period for FASB's exposure draft expired on August 30, 2002, with final guidance expected to be issued by year-end. The Association and its adjunct American Securitization Forum provided extensive comments to FASB in connection with these proposals. These comments focused primarily on the impact that these proposals would have on various categories of “risk-dispersing" SPEs, such as those employed in RLS transactions, for which consolidation should generally not be required. A complete copy of those comments may be obtained from the Association's Internet website, at the address contained in footnote 1 of this letter.

D. Investor Participation in the RLS Market

The Report notes that RLS do not have broad investor participation, and that these instruments have not attracted a wide range of investors beyond larger institutions. Several reasons are provided to explain this phenomenon, including that "the risks of these securities are difficult to assess" as well as "concems about the limited liquidity and track record of catastrophe bonds."

The above comments suggest that limited investor involvement to date in the RLS sector is due principally to the complexity and lack of a sufficient performance history of RLS, which has impaired their broader liquidity and marketability. We believe that this represents an incomplete and somewhat inaccurate portrayal of the dynamics of investor participation in the RLS sector.

Because of suitability concerns, RLS are not sold directly to individual investors.
However, we believe that they are entirely appropriate for mutual funds in which
individual investors hold shares. In fact, several major fixed income funds have purchased
RLS as part of their overall portfolios. As institutional investors, mutual fund managers
are well-equipped to perform the necessary analysis of relative value and risk associated
with RLS. From the perspective of a mutual fund investor, the complexity and risk
associated with RLS are no more pronounced than for other investment products that are
widely held by mutual funds, and that require a comparable level of sophistication to
comprehend basic investment risk (e.g., mortgage-backed securities, where valuation
analysis depends largely upon assessing the optionality associated with principal
prepayments by underlying borrowers). In addition, the low correlation of RLS with other
asset classes can enhance a fund's overall risk-adjusted return.

Moreover, it is not clear whether the lack of broader investor interest in RLS results from the absence of understanding of or demand for these instruments per se, or whether it is

'See letters dated August 22, 2002 and August 29, 2002 from the American Securitization Forum and the Association, respectively, to FASB in connection with the above-referenced exposure draft (both letters are available at www.bond markets.com)

Appendix VII

Comments from the Bond Market Association

See comment 3.

more simply a function of relatively limited issuance (which in turn is driven principally by reinsurance pricing levels, as discussed below). The supply of RLS brought to market to date has been readily absorbed by investors. There is no compelling basis to conclude that additional supply would not be similarly absorbed, possibly by a wider range of investors as liquidity concerns diminish. In fact, the universe of RLS investors expanded after September 11, 2001. This universe now includes several additional funds created specifically to invest in RLS. The additional commitment of funds to this asset class has contributed to a decline in the level of spreads in both the new issuance and secondary markets. This level is now below the level of spreads prior to September 11.

E. Importance and Global Interdependence of Reinsurance Pricing for RLS
Market

In several sections of the Report-principally, under the headings "Insurers are Subject to Reinsurance Price and Availability Swings" on page 16, and "Catastrophic Risk Can be Transferred to Capital Markets" on page 18, several references are made to the way in which reinsurance pricing affects the relative attractiveness of RLS to potential transaction sponsors. The Association agrees that reinsurance pricing is one of several important factors that drive RLS issuance. Traditional catastrophic reinsurance, RLS issuance and equity capital issuance are complements to each other, because they all address an insurer's need to maintain sufficient capital to meet claims made following a catastrophic event. If the cost of either traditional reinsurance or equity capital increases, RLS becomes more attractive. Perhaps more importantly for the growth of the RLS market, as the cost of RLS declincs, issuance rises because RLS becomes a cheaper source of capital.

8

Figure 4 on page 17 of the Report, which sets forth an index for US reinsurance pricing
between 1989 and 2001, shows an uptick in the price index in 1999, after a long
downward trend following the Northridge earthquake. The reason for this reversal is the
near record worldwide-insured losses in 1999 of approximately $28 billion, slightly under
1992 losses of approximately $29 billion. The primary causes of 1999 insurance losses
were two back-to-back winter storms in Europe, Lothar and Martin, that caused total
insured losses of approximately $7 billion. While not as dramatic as the insured losses
caused by Hurricane Andrew and the Northridge earthquake, these winter storm events.
together with a number of smaller losses occasioned by other catastrophic events that year
(including Hurricane Floyd), caused near-record insurance losses and were sufficient to
reverse the downward price trend in the reinsurance market. The central conclusion to be
drawn from these data, we believe, is the interdependence of reinsurance market pricing
(and thus the relative attractiveness of RLS) and, more specifically, the effect that non-U.S.
catastrophic events can have on U.S. reinsurance pricing.

A decline in the cost of RLS may result from several factors. The most important factor would be a decline

in spreads demanded by investors to clear RLS transactions. Another factor would be a decrease in the

expenses associated with the execution and ongoing administration of RLS transactions.

For clarity, we suggest that the title accompanying this graph specify that the index relates to pricing for catastrophic event reinsurance coverage.

Appendix VI

Comments from the Bond Market Association

Now on p.17.

See comment 4.

Now on p. 4.

See comment 5.

Now on pp. 5 and 18.

See comment 6.

Now on p. 17.

See comment 7.

Now on p. 17.
See comment 8.

Now on p. 18.

See comment 9.

On page 19, the Report states that "Demand by insurance company sponsors [to issue
RLS) will depend, in part, on basis risk faced and the ability of sponsors to hedge this basis
risk." This statement is correct, but could imply that a sponsor's ability to hedge basis risk
constitutes the principal motivation for RLS issuance. As suggested above, while the
ability to hedge basis risk is a factor that insurance company sponsors need to consider
when evaluating risk coverage options, reinsurance pricing is a critical driver of RLS
issuance.

II.

10

Specific/Technical Comments

For ease of reference, the following technical comments are keyed to specific page numbers of the Report:

Page 6: The first full sentence of this page states that "...catastrophe bonds involve higher transaction costs than traditional reinsurance..." This is not always the case, as the efficiencies associated with larger volume, multi-year RLS transactions can render these costs comparable.

Page 7, Page 21: These sections of the Report include statements to the effect that all catastrophe bonds (RLS) carry a non-investment grade credit rating. In fact, a small but growing percentage of newly-issued RLS has been investment grade." The emergence of dedicated RLS mutual funds seeking investment grade products has contributed to this trend.

Page 19: Data is cited at the bottom of the page stating that between 1996 and August 2001, approximately $11-13 billion of RLS were issued worldwide. These data include life and synthetic credit securitizations; since the focus of the Report is on catastrophe bonds, it may be appropriate to state that approximately $6-7 billion in catastrophe-related RLS were issued during this time period.

Page 19: At the top of this page, a number of investor preferences for nonindemnity-based insurance coverage are noted. We believe that it would be useful to point out that there are often compelling reasons for RLS transaction sponsors to utilize nonindemnity-based structures. Among other reasons, such structures may more effectively shield the confidentiality of the sponsor's underwriting criteria; may provide for more streamlined deal structuring and execution; and facilitate a more rapid payout in response to triggering

events.

Page 21: This section of the Report briefly discusses and contrasts catastrophe bonds with catastrophe options. Several relative advantages of catastrophe bonds are noted, including customizable offerings and multi-year pricing. We believe that the more important advantage that catastrophe bonds confer in comparison with catastrophe options is that the

10 Professional reinsurers have, to a limited but increasing extent, supplemented RLS transactions by providing sponsors of RLS transactions with basis risk reinsurance coverage.

"Non-investment grade RLS, as a percentage of RLS outstanding, has decreased from 94.7% in 1999 to 83.1% at June 30, 2002, according to Cochran Caronia & Co.

Appendix VII

Comments from the Bond Market Association

The following are GAO's comments on the Bond Market Association's letter dated September 10, 2002.

GAO Comments

1. Our report does not assign relative weights to the factors that lead to risk-linked securities being established offshore. We have added a footnote on page 21 to indicate that BMA believes that the principal reason risk-linked securities are organized offshore is to avoid taxation.

2. In contrast to BMA's view, we state that a primary reason for limited investor participation in risk-linked securities is that the risks of these securities are difficult to assess. Also, the risks of risk-linked securities and mortgage-backed securities are assessed differently. For example, the risk of loss from a natural catastrophic event, such as an earthquake in a specified geographic area over a specified time period, is often based on events that will only happen once over a long-time horizon and in some cases as long as an 100-year period. Therefore, investors must rely heavily on complex scientific analysis of the likelihood of the event, rather than statistical modeling. In contrast, the risk of loss from events such as defaults on home mortgage payments by borrowers occurs frequently, and extensive statistics are available to assess such risks.

3. We agree and our draft report discussed the relationship between reinsurance prices and interest in risk-linked securities as alternatives to traditional reinsurance. We also agree and have added a footnote on page 15 to indicate that U.S. reinsurance prices are influenced by catastrophic events outside of the United States.

4. We did not order by relative importance the reasons insurance
companies stated for their interest in risk-linked securities.

5. We have changed the text on page 4 by inserting the word "generally."

6. In our analysis, we relied on information provided by rating agencies for our discussion of credit ratings. Our draft report indicated that some catastrophe bonds contain tranches that have received investment-grade ratings. We added language to a footnote on page 18 to note BMA's statement that some newly issued, risk-linked securities have been investment grade.