Allianz Risk Transfer AG - Allianz Global Corporate & Specialty

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unusually high reserve releases after the termination of a traditional reinsurance contract. However, even without the one-time effect, the overall results nearly doubled compared with 2010. Positive earnings throughout the financial crisis demonstrate the still sound underlying margins of ART's business and the increasing diversity of deals executed within its three areas of expertise. In our view, this allows for positive earnings even under very demanding market conditions. The traditional portfolios currently consist of relatively small industrial lines business underwritten in Switzerland and the Gulf region, which together earned net premiums of about €100 million in 2011. These portfolios contribute to potential earnings volatility and have been posting losses in the past, but made a positive contribution in 2011. Foreign exchange effects can influence ART AG's profit and loss account because most of its transactions are in U.S. dollars or euros, whereas it reports publicly in Swiss franc. We base our analysis on euro values because ART is consolidated into AGCS and AZSE in this currency. Prospective In our view, the individual performance of various transactions demands management's close attention, given the currently challenging markets. However, the increasing number of transactions and broader risk diversity in ART's portfolio, as well as the termination of the alternative-assets business, should enhance earnings stability. For 2012 and beyond, we expect ART to achieve net income of at least €40 million on its nontraditional business. We expect the run-off process of its alternative-assets business to generate additional positive returns on average. Nevertheless, we acknowledge that individual years could be affected by adverse performance. For our ratings on ART, we assume that there will be no further material impairments on the company's alternative-asset transactions. For the traditional business, we assume a positive net income contribution. Investments: A Revised Asset Allocation Strategy After Run-Off Of Alternative-Assets Business Table 3 Allianz Risk Transfer/Investment Statistics --Year ended Dec. 31-- 2011 2010 2009 2008 2007 Total investments (mil. CHF) 2,088 2,037 1,779 2,058 2,497 Investment in affiliates (%) 4.4 4.6 6.0 5.2 3.8 Loans to affiliates (%) 4.1 5.4 7.0 5.1 0.0 Bonds and other fixed-interest securities (%) 78.7 70.8 72.2 39.2 35.4 Equities and other variable-interest securities (%) 0.1 0.1 0.4 10.2 15.3 Cash and bank deposits (%) 12.7 19.1 10.0 6.9 19.6 Other investments (%) 0.0 0.0 4.4 33.4 25.9 CHF--Swiss franc. Allianz Risk Transfer AG In our view, ART manages the assets backing its traditional insurance book prudently, both in terms of credit quality WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 3, 2012 10 1006376 | 301069137
and asset-liability matching. We expect the exposure on its alternative-assets portfolio to reduce gradually and ART to most likely reinvest these assets in bonds. We believe these risk-mitigation measures could stabilize investment income in the future and shift ART's risk-capital requirements from investment to insurance risks. Alternative-asset investments placed in transactions as part of ART's nontraditional business have historically exposed ART to high market risk and, in the past, to substantial impairments. Given the expected underlying future profitability of the currently 15 remaining alternative-asset investments, ART is not rushing to offload them. This means that the average life of the remaining exposures is still four years, with some longer than 10 years. As this portfolio continues to reduce, however, we expect ART's alternative assets to increasingly comprise highly rated investments. As of Dec. 31, 2011, bonds formed 74% of ART's total invested assets, cash 21%, equities 1%, reinsurance deposits 3%, and the remainder, other investments. Bonds are generally of a high quality, with 62% of the portfolio rated 'AAA', 22% 'AA', 7% 'A', 5% rated 'BBB', and the remainder in the non-investment grade category as of year-end 2011. ART tightly controls asset-liability mismatches by investing its technical liabilities in cash and bonds, and its investment guidelines limit mismatches within plus or minus 10% (currency mismatch) and plus or minus six months (duration mismatch). Liquidity: Strong, And Exposure To Risk Is Reducing Liquidity can be a major issue for providers of alternative risk transfer solutions. ART sets specific liquidity cover on transactions to match the most severe potential liquidity requirements. Nevertheless, certain financial transactions can also give rise to additional liquidity demands. We expect the termination of ART's alternative-assets business to reduce its liquidity needs over time. In addition, we don't expect ART to suffer any liquidity constraints because it actively manages its liquidity profile with a highly liquid investment portfolio and it has access to backup liquidity from its parent if needed. As of year-end 2011, ART's overall liquidity had remained strong. Capitalization: Strong, With A Strong Quality Of Capital ART's capitalization is strong, in our view. The company benefits from very strong capital adequacy as measured by our risk-based capital model, sound reserves, and comprehensive, tailored reinsurance protection. We believe that the company needs to operate with capital that is at least strong, to maintain a buffer against potential earnings volatility and finance further business expansion. We regard quality of capital as strong, with the majority comprising hard capital components such as shareholders' funds. Capital adequacy Capital adequacy benefits from a high proportion of shareholders' funds and risk mitigants within ART's transactions. We have assessed nontraditional transactions individually and applied conservative capital charges, based on our determination of the risk ART carries on its balance sheet. We generally reduce the exposure according to the credit quality of reinsurance or the credit quality of any security pledged or issued. Capital requirements for the nontraditional book are then input into our risk-based capital adequacy model, where we combine them with the requirements for the traditional book. The charges on ART's nontraditional portfolio amount to about 30% of the company's overall capital requirements at year-end 2011, in our capital adequacy assessment. Allianz Risk Transfer AG WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 3, 2012 11 1006376 | 301069137
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