Read TOPICS Magazine Issue 2/2011 text version


Issue 2/2011

Gas for Europe

1,224 kilometres across the Baltic: the Nord Stream pipeline is a mega project involving many risks. PAGE 6

Brazil A thriving market

Life insurance Innovative products are an important growth engine

Liability When treatment becomes a risk


Dear Reader, The debate on future energy supply is without doubt one of the most important of our time. As one of the world's leading risk carriers, we are directly affected by the consequences of climate change and have long supported the development of innovative technologies to exploit renewable energies. But we should be under no illusions here: coal, oil and gas will be around for a good few years yet and will continue to supply a large proportion of our energy despite the best efforts to replace them. One project that promises to give Germany and Europe greater energy security is the 1,200 km gas pipeline currently being constructed across the Baltic. It is the first direct link for Siberian gas to central Europe. The two pipelines will transport 55 million cubic metres of gas every year, enough to supply 26 million households with electricity and heating. Munich Re has been involved as a risk carrier in this technically challenging project from the outset. This issue of Topics also takes an in-depth look at Brazil, which is currently enjoying something of an economic boom. To maintain this progress, the country is investing heavily in infrastructure and energy. Such mega projects and the rising prosperity of the population are bringing about a significant increase in the demand for insurance in all classes of business. These are just some of the subjects dealt with in this issue of Topics. I hope you find the content interesting and of practical use in your work. And if you have any questions on the articles, simply contact the authors or your client manager.

Munich, July 2011

Dr. Torsten Jeworrek Member of the Munich Re Board of Management and Chairman of the Reinsurance Committee


MUNICH RE Topics Magazine 2/2011


Insurance cover from a single source

1,224 kilometres. Two pipelines, spanning the Baltic. Constructing the Nord Stream gas pipeline is a mega project involving massive risks and calling for risk expertise and excellent technical know-how. Munich Re has been involved in this project from the very beginning.



MUNICH RE Topics Magazine 2/2011


Brazil is now the fifth largest economy in the world. Growing prosperity and billiondollar investments in infrastructure and energy are increasing the demand for insurance cover.


Even the best physicians are not immune to making mistakes. With claims expenditure rising disproportionately, different countries are coming up with different solutions to this problem.


ENGINEERING Insurance cover from a single source COLUMN Who is "systemically relevant"? Banks and insurance companies are all too often tarred with the same brush. BRAZIL A thriving market Tough competition but major opportunities Kurt Müller, Head of MR São Paulo, talks about potential and challenges. INVESTMENTS Mandatory, not optional BaFin requires German insurers to conduct ALM. A complex task. Other countries in the EU should follow BaFin's example Professor Karel Van Hulle on the stringency of the German rules.


COLLATERISATION Safer than safe Is collaterisation of reinsurance recoverables really wothwhile? PRODUCT DEVELOPMENT New ideas are our trade Innovative products are an important growth engine.


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We want to grow with our clients Rudolf Lenhard and Klaus Wolf talk about the challenges of product development. LIABILITY IN MEDICAL PROFESSIONS When treatment becomes a risk Patient safety Professor Lackner of Munich University Hospital on the human factor in acute medicine. STANDARD FEATURES Editorial News Imprint


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UN uses tsunami map

"Discrepancy" by Roxy Paine

Three thick branches and a tangle of small twigs The stainless steel arms of the tree-like structure rise up to eleven metres into the sky. "Discrepancy" is the first permanent installation by US artist Roxy Paine in Germany. "The unusual power of Roxy Paine's sculptures lies in the fusion of natural forms and technical precision, permanency and transience, nature and culture", says Dr. Susanne Ehrenfried, Curator of Munich Re's art collection. The work of art can be seen outside Munich Re's new building on MariaJosepha-Strasse in Munich.

Call for entries

Every minute counts in an emergency: whenever the earth quakes in some part of the world or a storm lays waste to entire regions, helpers urgently need all the information they can get on the disaster area. The devastating catastrophe in Japan this spring was no different. When disaster strikes, Munich Re can provide a quick initial overview of the scale involved with the aid of calculations based on its large geodatabase. In March, this prompted one of the subsidiary organisations of the United Nations to incorporate a Munich Re map of modelled tsunami flood zones in its website for the use of international aid organisations and public authorities.

>> More information at:

The United Nations International Strategy for Disaster Reduction (UNISDR), the Global Risk Forum Davos (GRF) and the Munich Re Foundation have launched a highstakes disaster-prevention award which they presented at the world conference "Global Platform for Disaster Risk Reduction" in May. The prize is aimed at projects dedicated to disaster prevention and better risk management. Applicants have until 31 December 2011 to submit their proposals.

>> More information at: Projects/Disaster Prevention

NEWS IN BRIEF Top marks for Topics: Around 86% of all readers put Munich Re's client magazine in the top categories "excellent" or "very good". This is the result of a reader survey enclosed with Issue No. 1/2011. In addition, roughly 48% would not hesitate to recommend Topics. The Singapore International Reinsurance Conference will be held from 30 October to 2 November 2011 with the motto "Asia's Growth: Are We Capitalising On It?". The keynote address will be given by Nikolaus von Bomhard. Pina Albo, Head of the National Clients sector at Munich Re America, was voted Insurance Woman of 2011 by the Association of Professional Insurance Women (APIW) in April. Since June, users have been able to access a new e-learning module at The interactive learning program "Financial statement analysis for insurance companies" focuses on essential balance sheet ratios, their calculation and their interpretation in accordance with the German Commercial Code (HGB) and IFRS. Munich Re in Paris celebrated an important anniversary in May: 125 years ago, on 23 May 1886, our company set up its first foreign branch in the form of a representative office in the French capital. This date marks the beginning of our company's international operations. The Munich Re Executive Forum Life on the subject of "Change and Innovation" will take place from 7 to 10 November. Contact your client manager for more information.


MUNICH RE Topics Magazine 2/2011

Natural catastrophes set depressing record

Earthquake and tsunami in Japan, major quakes in New Zealand, a series of tornadoes in the USA. Just six months into the year, 2011 has already gone down in history as the year with the highest losses due to natural catastrophes. The overall economic loss was more than five times higher than the first-half average for the past ten years. Insured losses were also nearly five times greater than the average since 2001.

>> More information at:

MUNICH RE Topics Magazine 2/2011



MUNICH RE Topics Magazine 2/2011


Insurance cover from a single source

Pipelines are among the most challenging risks in offshore business. This is especially true of mega projects like the gas pipeline across the Baltic Sea. The Nord Stream consortium chose Munich Re as the leading insurer for this project.

Pipe-storage facility in Mukran on the German island of Rügen. Over 200,000 12-metre-long pipes are delivered to the coating plants for the application of a concrete protection layer. MUNICH RE Topics Magazine 2/2011 7


Joachim Wiechers and Thomas Friedrich

Nord Stream, a consortium of Gazprom, Wintershall, E.ON Ruhrgas, GDF Suez and Nederlandse Gasunie, is installing two parallel pipelines directly linking Europe and the Russian gas fields via the Baltic Sea, from Vyborg in Russia to Greifswald in northeast Germany (see Fig. 1). Total investment is projected at 7.4bn. Each pipeline is 1,224 kilometres long; together, they will transport 55 billion cubic metres of natural gas per year, sufficient to supply 26 million European households with electricity and heat. This will be one of the largest offshore projects ever to have been realised. The first pipeline is scheduled to start operations in October 2011. Such a technically sophisticated and complex project imposes considerable demands on all concerned. Take the logistics, for example: more than 200,000 pipe segments each measuring 12 metres in length must be manufactured, delivered, coated in concrete, transferred to the logistics centres and finally transported by ship to the pipelay vessels at exactly the right moment in time. The individual segments are then welded together by robots and lowered to the seabed. The ships must lay the pipes within a very narrow corridor because the two pipelines run through the exclusive economic zones of Sweden, Denmark and Finland.

Underwriting the pipeline through the Baltic Sea is the most comprehensive underwriting project undertaken by the offshore risks department to date and the largest facultative single risk ever to be found on the books of Munich Re.

Munich Re first offered facultative insurance of offshore construction projects on a large scale a little more than ten years ago. Following the successful conclusion of several reference projects, including Blue Stream (in the Black Sea), Greenstream (Mediterranean) and Dolphin (Persian Gulf), the Facultative Energy unit was able to achieve the lead position with a substantial share in the Nord Stream project in the summer of 2008. It is the most comprehensive underwriting project undertaken by the offshore risks department to date and the largest facultative single risk ever to be found on the books of Munich Re. The most important point for Nord Stream was to ensure comprehensive insurance cover commensurate with the risk throughout the different phases of the five-and-a-half year project. This forward-looking approach distinguishes Nord Stream from other projects in which insurance issues are often only tackled at a relatively late juncture. Scope of cover defined at an early stage It all started with the transit risk. Cover was needed for the pipes' transportation from their various production locations to the coating plants in Kotka in the Gulf of Finland and Mukran on the German island of Rügen, where the pipes were to be coated in concrete. This could easily have been realised through a classic marine cover. Even at this early stage, however, steps were taken to ensure an integrated insurance solution, with appropriate limits and adequate distribution of the risk in the later phases. The risk was therefore written from the outset in the offshore energy market.

Experience and flexibility win the day The challenge for Munich Re therefore was to develop a viable insurance concept from start to finish of this highly complex project. In doing so, all the different interests of risk managers, banks and insurers, as well as the know-how of brokers and experts, had to be reconciled. In addition to a large measure of flexibility, this also required a willingness to actively communicate with the partners and to develop constructive proposals.


MUNICH RE Topics Magazine 2/2011


Fig. 1: Route of the Nord Stream pipeline through the Baltic Sea



Vyborg Kotka




DENMARK Karlskrona


S ord




Mukran Greifswald GERMANY




The 1,224-km-long Nord Stream pipeline runs through the Baltic Sea mostly outside the 12 nautical mile zone of the coastal states, but always within each country's exclusive economic zone. From the five strategically located logistics centres, supplies can be delivered to the pipelay vessel within 24 hours.

Planned pipeline route Boundary of the economic zones Boundary of national territorial waters Coating plants and logistics centres Source: Nord Stream

Phase 2 involved coating the pipes in a concrete layer between 60 and 110 mm thick in order to increase their resistance to mechanical damage. From these coating plants, the pipes were then sent to the logistics centres supplying the pipelay vessels. Once again, the parties responsible left nothing to chance when selecting these storage locations: all five locations were planned to ensure that they were always less than 100 nautical miles from the pipelay vessels. Everything had to be planned with military precision to ensure that the over 200,000 individual segments were always delivered at exactly the right moment in time. Munich Re was also selected to cover this phase of the largest logistics project ever undertaken in the Baltic region, after various combinations of limits and retentions had been negotiated.

The third phase encompassed the most complex risk: the actual laying of the pipelines in the Baltic Sea. Laying pipelines on land normally does not pose any major problems, but this is vastly more difficult at a depth of up to 200 metres below the surface of the sea. If problems are encountered here, they give rise to high costs as the repair work can only be undertaken by special-purpose ships with special equipment. In addition, the pipeline runs through the economic zones of several Baltic countries. Should pipe repairs make it necessary to leave the designated lay corridor, extensive negotiations could disrupt the schedule.

MUNICH RE Topics Magazine 2/2011



Pipe-laying involves particular risks Innumerable mines were laid in the Baltic Sea during the last two World Wars, and particularly after the First World War, ordnance which was no longer needed was simply sent to the bottom of the sea. Among other things, this also includes old grenades containing chemical warfare agents. The pipe-laying corridor for the Nord Stream pipeline crosses these particularly dangerous areas at various points. Nord Stream has therefore taken extensive precautions to minimise this additional risk. The seabed has been surveyed in detail and searched for mines. Wherever necessary, the actual pipe-laying work has been preceded by mine-sweeping activities. The remaining and by no means negligible risk due to undiscovered mines and other unexploded ordnance is also covered by the policy. In addition to this specific hazard, the pipe-laying work itself also entails a considerable risk. According to an assessment by the international inspection and certification society Bureau Veritas, a loss must be expected roughly every 1,000 kilometres when laying the pipeline. In statistical terms, this means that Nord Stream should incur 2.4 losses. In the worst case, the pipeline would be so severely damaged while being laid that the pipe ruptures and seawater can enter. In the trade, this is known as a "wet buckle".



3 1: Roughly three hours are needed to load 90 coated pipes each weighing 25 tonnes on to a transport vessel in the logistics centre. 2: The pipelay vessel Castoro Sei, which is responsible for laying more than 850 km of pipeline, receives up to three deliveries of pipe segments. 3: Up to 250 pipeline segments are welded together on board the Castoro Sei every day. 4: All welds are examined with millimetre precision by non-destructive testing in order to identify possible defects before the weld is finished with a PU coating.



MUNICH RE Topics Magazine 2/2011


Due to its weight, the Nord Stream pipeline could only be recovered to surface in relatively shallow waters and then repaired on board a pipelay vessel. For most of the route, however, the sea is too deep to permit such repairs, with the result that the necessary welding work would have to be undertaken directly on the seabed. Norwegian firms have refined a technology using pressure chambers on the seabed for these repairs. So far, however, the method has only been employed on pipes measuring not more than 44 inches in diameter ­ the Nord Stream pipes measure 48 inches. A fully developed and tested method for repairing damaged pipelines in deeper water consequently did not exist when the insurance solution for phase 3 was being negotiated. This substantially increased the underwriting risk, particularly as there is no alternative means of repairing the pipes. Correctly assessing the risks and establishing suitable limits of indemnity not only called for technical know-how but also required a holistic view of the risk to be taken, with experience from previous projects proving very useful. A first-loss limit was agreed with Nord Stream ­ for each line of the pipeline. In May 2011, the three segments of the first pipeline were installed on schedule and without incident. These pipeline segments are currently undergoing testing and will be subsequently welded together. Initial operations on the first line are expected to commence at the end of the year once final tests have been completed.

5: The finished pipeline leaves the pipelay vessel via the stinger with an unsupported span before touching the seabed. Special holding devices known as tensioners keep the pipeline taut to prevent it buckling.


MUNICH RE Topics Magazine 2/2011



This considerable preventive effort has repeatedly paid off on major pipeline projects.

Phase 4 involves insurance of the pipelines during operation. The main challenge is that, when the first pipeline is taken into service, the laying of the second line will still be under way directly alongside. The policy must therefore be worded so that it also covers potential damage to the first pipeline, for instance by an anchor from a pipelay vessel. The contract extension for this phase was signed in February 2011. However, the work is by no means over when the contract has been signed. Such a complex project requires constant verification of the risk situation to ensure that all parties in the project also fulfil their duties. A Marine Warranty Surveyor is permanently on hand for this purpose to identify critical developments and report on changes in the risk situation. Risk control also includes loss workshops with the client, during which possible scenarios are developed in order to be prepared for the real thing. This considerable preventive effort has repeatedly paid off in practice, also on other major pipeline projects. The Nord Stream project is due for completion in October 2012, when the second line will also be taken into service. However, we are already looking further ahead. There are several pipeline projects planned for the coming years, including the South Stream line through the Black Sea.

OUR EXPERTS: Joachim Wiechers is an expert and senior underwriter in the Centre of Competence for Offshore Risks in the Facultative Energy unit. [email protected]

Thomas Friedrich is a technical expert and underwriter for offshore oil and gas energy risks in the Facultative Energy unit. [email protected]


MUNICH RE Topics Magazine 2/2011


Economics from a risk perspective

Who is "systemically relevant"?

Dr. Michael Menhart, Head of Economic Research at Munich Re [email protected]

Systemic risks pose substantial challenges for the financial services industry and the global economy. The right conclusions need to be drawn from the crises of the last few years in regulating the financial sector. For nearly three years now, a spectre has been haunting the financial world ­ systemic risk. It first emerged on 15 September 2008, the day Lehman Brothers collapsed. In the aftermath, governments and central banks had to stump up hundreds of billions to prevent a collapse of the global financial system and a potential domino effect on the global economy. The reason usually cited for these unparalleled rescue operations was the "systemic relevance" of the financial institutions involved. Systemic relevance has also played a significant part in the crisis involving the peripheral eurozone states. Greece`s economic output makes up just 2% of the eurozone`s total. So why is its debt crisis generating so much attention, anxiety and activity? It is mainly the concern that the crisis will spread to other peripheral states of the eurozone or impact major financial institutions in Europe and beyond.

The systemic risk issue is therefore rightly at the centre of debate on future financial-market regulation. "Carrying on as before" is unthinkable after the experience of the last few years. Systemic crises in the financial world may have such serious economic repercussions that huge political and social upheaval cannot be ruled out at some point, even in established democracies. However, that does not mean it is right to tar all business models in the financial services industry with the same brush, as has frequently been the case. The core activities of (re)insurers, in contrast to those of banks, are not systemically relevant ­ this fact cannot and should not be ignored. Yet what exactly does "systemically relevant" mean? The insolvency of a company always has unpleasant consequences for customers, employees or shareholders. But we can only speak of a systemic risk if the failure of a financial institution has a significant negative impact on the financial system as a whole and/or the real economy. There are four main criteria for assessing whether insurers should be classified as systemically relevant or not: size, interconnectedness, substitutability and timing. Major differences are evident in terms of size alone: the total assets of the 50 largest global banks are four times higher than those of the top 50 global insurers, or over 40 times

higher than those of the top 40 global reinsurers. The degree of interconnectedness in the insurance industry is markedly smaller than in the banking sector, so the risk of contagion in the event of an insolvency is very limited. Besides this, supervisory regulations ensure that if an insurer becomes insolvent, an "orderly winding-up" of the business is possible, with liabilities being settled from reserves. In addition, the industry is very competitive ­ no one insurer has a monopoly or a controlling market position. In the rare event of an insolvency, the lost capacity is therefore quickly substituted as a rule. Also of major relevance is timing. For the most part, liabilities are not liquid and payments to clients extend over prolonged periods. A sudden cash outflow comparable to a bank run, along with its destabilising effects and risk of a general crisis of confidence, is not possible. For these reasons, insurers ­ with their core activities and their liabilitydriven business model ­ do not constitute a systemic risk. On the contrary, they even contributed significantly to the stability of financial markets and the real economy in the financial crisis.

MUNICH RE Topics Magazine 2/2011



MUNICH RE Topics Magazine 2/2011


A thriving market

The largest country in Latin America now ranks fifth among the world's national economies. Growing prosperity and billions invested in infrastructure and energy have triggered a rising demand for suitable insurance solutions.

Christian Garbrecht

In the last two decades, Brazil's economy has developed at such a breathtaking rate that it is sometimes called the "milagre brasileiro", the Brazilian miracle. What led to this exceptional turnaround? At the time of the international debt crisis of 1982, Brazil was still classed as a highly indebted developing country and several currency reforms proved necessary. The situation only stabilised when the real was introduced as legal tender in 1994. Several factors have influenced Brazil's positive economic development. By the time the last crisis ended in the late 1990s, Brazil had developed a sound economic policy and was able to strike a balance between political intervention and market forces. The Brazilian market has concentrated on domestic consumption and was not unduly affected by the international crisis in recent years. The development and implementation of social programmes, as well as a state framework for investments, were key factors. Both the social system and the tax system were reformed in 1994 and efforts are being made to improve administrative efficiency. Although the country is beset by great regional and social rifts, its unity

is undisputed. Its political system is also stable ­ a significant factor in attracting foreign investors. One demographic advantage Brazil has over other countries is that it has a very high ratio of workers to pensioners. Social mobility is also increasing: a large proportion of people on very low incomes are able to improve their situation. All the country's economic indices are looking up Since the late 1990s, Brazil's development has been extremely positive. Real economic growth since 2000 has averaged around 4% per year. In addition, Brazil is one of the countries that have emerged from the financial crisis relatively unscathed ­ its real gross domestic product (GDP) declined by only 0.6% in 2009, as compared to a drop of 1.9% worldwide. According to economic forecasts, Brazil will continue to grow by between 5% and 6% per year between 2011 and 2020. Now the largest national economy in Latin America and home to almost half the population of the subcontinent, Brazil currently ranks fifth on an international scale. In terms of purchasing power parity, Brazil's GDP is the highest of all American countries except the USA. It has even outstripped Canada, an industrial nation. Unemployment totalled 5.3% in 2010, the lowest level in eight years. Together with exports, domestic consumption by the country's relatively young population (see the chart of demographic development on page 20) consequently remains the

With a population of around 20.3 million, São Paulo is the second largest city in Latin America ­ and the third largest worldwide after Tokyo and Mexico City. São Paulo State is seen as Brazil's economic motor. MUNICH RE Topics Magazine 2/2011 15


main driving force. Brazil has a positive balance of trade, as the country exports more than it imports, especially agricultural produce such as soya, maize and coffee, the price of which has already risen considerably this year. Although private investment is increasing, the projects implemented in conjunction with PAC 1 and 2 (Programa de Asceleração do Crescimento; the programme to accelerate growth) remain an important motor. The programme provides for investments of more than R$ 600bn (around 275bn) which are designed, above all, to promote areas of critical importance to the country's further economic development, such as infrastructure, power generation and socially compatible urban development. The government is focusing on renewable energy sources. Under PAC 2, around R$ 89bn (40bn) is to be invested in the construction of new hydro power plants between 2011 and 2014. The forthcoming major sporting events, the World Cup in 2014 and the 2016 Olympic Games, are expected to provide further stimuli: Rio de Janeiro anticipates investments totalling around 35bn just for these two events in the next five years. Spurred by favourable basic conditions, direct foreign investment has increased continuously. By 2020, the investment bank Itau BBA believes investments in Brazil will have reached three times their present value of 230bn. And the positive trend is expected to

continue through to 2020/22, as the middle class expands considerably, thus boosting demand for goods and services, as well as the need for further infrastructural measures. Despite all the pleasing trends, however, the government must also keep track of several challenges and pursue a balanced economic policy to heal the country's social and regional rifts without imposing excessive constraints on business. More attention must also be paid to combating the country's high inflation which, in 2010, had almost reached the peak of the forecast inflation curve (see Fig. 1). To counter this development, interest rates were raised and the national budget was capped. Expanding insurance industry With roughly 40% of the total gross premium written, Brazil is by far the largest insurance market in Latin America, followed by Mexico, Argentina and Colombia. It is growing continuously, at rates considerably higher than the increase in GDP which except for 2009 has always been in the order of 5% (see Fig. 2). For the years up to 2016, experts expect real growth in the insurance market to average over 6% per year for property and casualty, while life is expected to grow by around 17%. All in all, there are 132 mostly composite insurance companies operating in Brazil (as at the end of 2010). The Brazilian insurance market is highly concentrated, with the ten largest non-life companies underwriting more than 80% of the market premium.

Fig. 1: Inflation curve from 2006 to 2015e 6.5 in % Inflation has remained relatively high in recent years, but the government is taking steps to control it. e: Expected level 5.5 Source: IPEADATA 5.0





2006 2007 2008 2009 2010 2011 2012e 2013e 2014e 2015e


MUNICH RE Topics Magazine 2/2011


Compared with Europe and Asia, the insurance industry accounts for a small share of Brazil's GDP; in relation to other Latin American markets, the country occupies a middle position. Experts believe that the insurance market is heading for a "golden age": they expect market penetration in all classes to grow from 3.8% to 6.5% of GDP in the next seven years. Economic reforms and government programmes have spurred the non-life sector in recent years, causing it to expand by almost 50% between 2005 and 2009. Additional premiums of around 3bn are expected for the next six years. However, rising incomes and greater risk awareness in the population will also contribute to the insurance industry's growth. Life insurance in particular is booming, due above all to high demand from the new middle class. In the coming years too, products for this target group with over 30 million potential clients will no doubt lead to further growth.

Liberalised reinsurance market For 69 years, the reinsurance market was dominated by the monopolistic state reinsurer IRB (Instituto de Resseguros do Brasil S.A.) while foreign reinsurers were only able to operate as retrocessionaires for the IRB. In January 2007, a law was passed that opened the market to other reinsurers from 2008 onwards, albeit with restrictions (see the interview on page 22). This law came into force in April 2008. Among other things, this liberalisation aimed to modernise the insurance sector, as well as to increase the available reinsurance capacity and create additional incentive for investments. Expansion of the insurance industry will play a crucial role in the country's further growth, as the major infrastructure and energy projects required can only be implemented with the industry's assistance. Since 2008, foreign reinsurers have been able to operate in three different forms ­ as "ressegurador local", "admitido" or "eventual". Local reinsurers must be Brazilian companies presenting their own financial statements, comply with supervisory and solvency regulations and have a certain minimum equity. They are not permitted to engage in primary insurance.

Fig. 2: Growth of the insurance market 160 R$ bn 140 120 100 80 60 40 20 0

2006 2007 2008 2009 2010 2011 2012e 2013e 2014e 2015e

The insurance market (here: gross premiums written) has grown considerably faster than GDP in recent years (2006: 4.0; 2007: 5.7; 2008: 5.1; 2009: 0.2; 2010: 7.5; 2011e: 7.5). Primary insurance (non-life) Primary insurance (life) Primary insurance (total) e: Expected level Source: IPEADATA

MUNICH RE Topics Magazine 2/2011


Renewables lead the way

When it comes to power generation, Brazil is relying on renewable energy sources, such as wind and hydro power. Munich Re is a major player in several current projects. Three examples:

Santo Antônio hydro power plant on the Madeira River One of the world's largest hydro power plants is currently under construction in the northwestern state of Rondônia. With an installed capacity of 3,150 megawatts and an investment volume of more than R$ 10bn, the project is a milestone for hydro power in northern Brazil. When the plant is completed in 2015, after seven years of construction, 44 bulb turbines will have been installed. The scale of the project is vast, requiring the diversion of the river to make way for the construction of the plant (see photo at bottom right). When this risk was to be placed in 2008, Munich Re in São Paulo was contacted on account of its special expertise in engineering insurance. Quoting the covers involved proved to be a challenge due to the scale of the project and the special terms of insurance required. The insurance covers property valued at roughly 5.5bn during the construction phase; financial losses resulting from a sudden insured property loss are covered in the amount of 705m. The client also wished for the plant to be insured immediately upon commissioning so as to avoid any gap in cover. After careful analysis within a tight time frame, Munich Re was able to present a solution which found favour with both the policyholders and the project's investors. Munich Re has underwritten a leading share of the risk and is closely monitoring the progress of the project through its local engineers.

Wind farms in Bom Jardim and Água Doce Many parts of Brazil are ideal locations for wind farms. The country's growing demand for electricity can therefore be met by renewable energy sources. In late 2010, Brazil had an installed wind power capacity of 930 MW, which is still fairly low in relation to the worldwide volume of 194.4 GW. Under the government's PAC programme, however, capacity is to be increased fourfold in the medium term. The wind farms in Bom Jardim and Água Doce in the southern state of Santa Catarina are major projects to help meet this target. The two complexes comprise six and four wind farms respectively, which will generate 91.9 MW and 125.8 MW of electricity with a total of 148 wind turbines. Their insured value totals more than 500m, 80% of which is covered by Munich Re.

Belo Monte hydro power plant on the Xingu River In the medium term, Brazil plans to invest up to 50bn in hydro power plants as part of the PAC programme. The Belo Monte dam is the largest project: with an installed capacity of roughly 11,000 MW, it will be the third largest power plant of its type in the world. After several years of planning, work on the project started in April 2011 and is scheduled for completion in 2019. More than 7bn is being invested here, with an insured value of 10bn. Following lengthy negotiations occasioned by the project's complexity and eight-year construction period, Munich Re became the leading reinsurer of the dam's construction phase.

The Madeira River in the northwestern state of Rondônia. The Santo Antônio hydro power plant is currently under construction here.


MUNICH RE Topics Magazine 2/2011


Approved reinsurers ("admitido") must have a branch operation in the country, but do not underwrite business locally and do not present their own financial statements. In addition to security of US$ 5m deposited with the supervisory authorities, they also require a rating of at least BBB. The third type of reinsurer ("eventual") are registered, but do not have a local office and accept reinsurance treaties in Brazil from their location abroad. A minimum rating of BBB and minimum equity resources of US$ 150m are mandatory. What is more, their head office must not be located in any country levying income tax at a rate of less than 20% or in which the ownership structures are not publicly verifiable. Since the market was liberalised, 97 reinsurance companies have registered in these three categories in Brazil. Munich Re in Brazil As Munich Re has maintained business relations with Brazil since 1951 and set up its local office Münchener Rück do Brasil Serviços Técnicos Ltda in 1997, it was able to register as the first "ressegurador local" with foreign capital in 2008. The subsidiary's establishment was a logical consequence of our confidence in the country's positive development and our long-term strategy for Latin America. "It was really hard work to set up the business at that time", says Kurt Müller, head of the local subsidiary, today (see interview on page 22). With premiums totalling 172m in 2010, Munich Re do Brasil is now the largest foreign reinsurer in the country.

Munich Re offers the full range of insurance solutions in Brazil, especially in those classes of business in which reinsurance is not yet fully developed, such as agriculture, life and healthcare. As one of the world's leading risk carriers, we develop tailor-made solutions for even highly complex risks. Besides this, special services allow our clients to profit from our expertise in such areas as underwriting or (reinsurance) accounting. From the very outset, our activities in Brazil focused on engineering covers and we therefore continue to be involved in a number of major infrastructure projects (see box on the left). Thanks to our underwriting units for treaty and facultative business, as well as a claims department, we have the local structures needed to support our clients in these major projects. We not only offer assistance with quotations and provide capacity, but are also on hand as consultants during the construction phase and advise clients with regard to loss prevention.

>> Further information on our activities in different classes of business can be found at

OUR EXPERT: Christian Garbrecht is responsible for risk management and financial control at Munich Re in São Paulo. [email protected]

MUNICH RE Topics Magazine 2/2011



A land of contrasts

As far apart as the North Cape and Gibraltar: at its widest points, Brazil measures around 4,300 kilometres from east to west and from north to south. With a total area of around 8.5 million square kilometres, the fifth largest country in the world occupies almost half the South American continent, extending from 5° N to 34° S. It is therefore hardly surprising that both the country and its people are extremely diverse and varied. Brazil is made up of 26 federal states and a federal district (Distrito Federal do Brasil) which is controlled directly by the national government. Most of the country's 195 million inhabitants live in the south and southeast around the metropolitan areas of São Paulo and Rio de Janeiro. This is also Brazil's industrial heartland. In the much less densely populated north, natural resources play an important part in the local economy. The country's raw material deposits are immense. Along with machines and iron ore, many of Brazil's main exports are agricultural products, including coffee, cocoa, tropical fruits, soy beans and sugar. Around 40% of Brazil's agricultural exports go to the European Union and just under one-fifth to the USA. Boasting vast tracts of cultivable land, Brazil could well end up feeding a growing world population.

Symbolic: The flag's green background represents the country's abundant forests while the yellow lozenge stands for its gold deposits, the blue circle for the night sky over Rio and the white stars for its 27 federal states. The white band contains the motto "Ordem e Progresso" (Order and Progress).


Population structure

Population growth

210 million inhabitants 200 190 180 170 160 150 140 130 1985 Years 1990 1995 2000 2005 2010e 2015e

Age pyramid 2010

100 years 90 80 70 60 50 40 30 20 10 0 10 8 6 4 2 0 2 Population in millions 4 6 8 10 Male Male Female Female

Unusual: The country's age structure still forms a pyramid, a shape almost unknown today in the majority of industrial nations. Almost 60% of Brazil's population are under 30 years old.

Source: CELADE ­ Centro Latinoamericano y Caribeño de Demografía


MUNICH RE Topics Magazine 2/2011

Hydro power potential

Land of water: Brazil is the home of the Amazon, the world's largest river system with a maximum length of 6,448 kilometres and carrying 209,000 cubic metres of water per second. It carries 20% of the world's fresh water. The rainforests surrounding the Amazon are known as the Earth's lungs and are home to more species than any other part of the world. In the east, the river Iguazu runs along the border with Argentina ­ its falls, called the "Garganta do Diabo" (Devil's Throat) (photo on the right), dwarf the Niagara Falls by comparison: the cataract comprises 20 larger and 255 smaller falls extending over a length of almost three kilometres. In future, the country's vast water reserves will be increasingly used to generate clean energy.

A great sporting nation

Sporting glory: The Brazilians' love of sport is legendary. Brazil has won the FIFA World Cup a record five times and will host the next tournament in 2014. Work on construction and upgrading of stadiums is already in full swing. Natal


São Luis Fortaleza Teresina





Belo Horizonte

São Paulo Curitiba

Rio de Janeiro

Brasilia: This specially planned capital city was constructed within the space of just three years in the 1960s. Only about 2.2 million people live in the city itself. Rio de Janeiro: Rio was the country's capital for almost 200 years, until 1960. Due to the city's geographic location, tourism is a particularly important economic factor here. São Paulo: This is the most densely populated region. In the wake of industrialisation, its population has doubled to around 20.3 million inhabitants in the last 40 years.

Porto Alegre

North and south, town and country

Uneven spread: Roughly 80% of Brazil's population live in cities, most of them on the Atlantic seaboard. In the federal district and in the state of Rio de Janeiro, there are an average of 300 people per square kilometre. In the mountainous north and in the Amazon region, on the other hand, there are as few as three people per square kilometre.

MUNICH RE Topics Magazine 2/2011



Tough competition but major opportunities

Brazil is booming. Kurt Müller, Head of the subsidiary in São Paulo, sees a great deal of potential in the country ­ always assuming that its basic economic and regulatory conditions remain stable.

Kurt Müller has been in São Paulo since 2006 and experienced the changes there at first hand. Before coming to Brazil, he worked for Munich Re in Japan and South Africa.

Topics: Mr. Müller, the Brazilian reinsurance market was liberalised three years ago. What prompted this decision after maintaining a monopoly for decades? Kurt Müller: The Brazilian government has privatised a number of state-owned enterprises since the early 1990s in order to speed up the country's economic development. The programme leading to a gradual liberalisation of the reinsurance market was launched back in 1998. It was hoped that this would lead to a modernisation of the insurance sector, for instance by prompting foreign insurers to enlarge the product range with their international know-how. It was also hoped to attract more foreign investment at the same time. What has changed since then? As a result of the ­ gradual ­ liberalisation, there are now 97 registered reinsurers in all three categories. Reinsurance law requires that 40% of a programme must be placed with local companies. International reinsurers which have set up local subsidiaries, such as Munich Re, qualify as local companies and can participate in this first 40%.

Munich Re was the first international reinsurer to be registered in 2008. Was this the reward for our longterm commitment there? Munich Re has been active in Brazil for several decades. We reacted as soon as the first signs of imminent liberalisation emerged in the 1990s. A service office was opened in São Paulo in 1997, incidentally under the leadership of Munich Re's present CEO Mr. von Bomhard. In those days, we essentially acted as retrocessionaire for the monopolistic reinsurer Instituto de Resseguro do Brasil (IRB). Yet the expected opening of the market failed to materialise. Unlike other companies, however, we stayed put, with the result that we were able to react swiftly when the law on liberalisation was somewhat unexpectedly passed in 2007 and we were the first international reinsurer to file our application with the supervisory authority. We were registered just three months later. Today, we are the largest local reinsurer after the IRB.

What would you say were the main factors behind this success? Every possible resource was deployed. It was really hard work to set up the business at that time, as we had to establish the underwriting departments for the various lines of business and the reporting structures, among other things. This was something which my 20 local colleagues and I naturally could not handle alone. It would have been impossible without the management's backing and clear strategy, as well as the close collaboration of our colleagues in Munich. What has changed for Brazil's insurers since the market was opened up? Liberalisation still presents major challenges for the entire market. Until 2007, the conditions for placing business were clearly specified and the IRB took over a great deal of the insurers' administration work. Now, however, they first had to set up reinsurance departments, recruit the necessary specialists, build up knowhow and develop guidelines or align their IT systems to their international business partners. What's more, the competition is very fierce, as many brokers also moved into the market.


MUNICH RE Topics Magazine 2/2011


How can Munich Re help its cedants to master these challenges and how will it continue to do so? Our cedants need not only capacity, but above all expertise, particularly in accounting and finance, as well as in underwriting. We are able to help smaller companies in particular, as well as those which specialise in certain classes of business. Larger insurers are helped, in particular, with the underwriting of very large and complex risks. Since our staff have an intimate knowledge of the local market and are able to draw on Munich Re's network, we were able to provide these services from the very outset. Our reinsurance fair last year also attracted a large number of visitors. And we naturally organise local seminars in Brazil too, or invite clients to training courses in Munich. Do you also cooperate on product development? Yes, we do. One major motivation for opening up the market was the desire to introduce more modern insurance products. Right now, we are working together with one client to establish travel insurance in Brazil. Where are Munich Re services in greatest demand? Brazil is probably the world's biggest building site today, firstly because of the government's economic programmes to vastly expand the country's infrastructure and secondly on account of the major sporting events scheduled for 2014 and 2016. Immense sums are also being invested in renewable energy sources. We can offer support in all fields by underwriting facultative business and reinsuring complex large engineering risks. Surety insurance also plays an important part here.

As in Europe, new solvency guidelines are to be drawn up for Brazil. What changes will this bring for the country's insurers? Brazil has developed its own solvency model. The new rules based on the Pillar 1 framework will be introduced in stages in the period up to 2012. They initially provide for variable capital calculated on the basis of the underwriting risk, the breakdown of business in the various regions and the amount retained per company. Other factors, such as the credit risk, market risk, legal risks and operative risks, will be included in the calculation later. Small companies and monoliners will be affected most strongly by the new rules, but all insurers, large and small, will require more capital. However, capital requirements are rising not just on account of the new solvency guidelines but also as a result of growth as such. To what extent can reinsurance provide relief here? We can offer our cedants customised solutions: a precisely tailored reinsurance programme can release capital for use elsewhere. Besides, we can advise our clients when modelling their capital allocation and assist with dynamic analyses of their portfolio, as well as with asset-liability management. Brazil is one of the world's largest agricultural producers. Around 30% of the Brazilian population either work directly in agriculture or are indirectly dependent on it. How can Munich Re help the agricultural sector? Agriculture is indeed one of the most important sectors in Brazil. Some 25% of the soya produced worldwide comes from Brazil and agricultural production is expected to continue to grow. However, agricultural insurance is still in its infancy, covering just 11% of the cultivated area of the main crops. The government recently launched a programme to subsidise crop insurance premiums, but this system has still to be developed further. Due to the volatility of this

business, it cannot be handled by private insurance companies alone. Munich Re is therefore backing public-private partnership (PPP) models. Such risk-transfer mechanisms have already passed muster in other countries. For Brazil, the next step would be to introduce a comprehensive crop insurance system with guaranteed financial support from the state, both as regards the premiums and in the event of a catastrophe. We can not only offer to advise the government agencies here, but also provide our cedants with capacity and a supporting service, as well as portfolio analyses and PML calculations. Brazil is now the fifth largest national economy in the world. Do you think the exceptional growth of recent years can continue at the same pace? In the last few years, the country has seen a huge increase in domestic consumption by its young population. The economy is booming and the middle class growing. This growth will be stimulated further by the World Cup and the Olympic Games. The insurance industry stands to benefit here due to the resultant plethora of construction projects and the rising demand for motor or life insurance. On the downside, inflation is starting to climb. The main job facing the new government is therefore to prevent the economy from overheating. No matter how euphoric we may be today, it will be important to keep an eye on how prices develop in the next few years.

MUNICH RE Topics Magazine 2/2011



Mandatory, not optional

BaFin's latest investment circular requires German insurers to have ALM in place. A complex task ­ but Munich Re can help.

Excellent asset-liability management is crucial to an insurance company's success.


MUNICH RE Topics Magazine 2/2011


Bernd Proeller, Rainer Stragies and Martina Englmann

In April 2011, the German Federal Financial Supervisory Authority (BaFin) published its investment circular No. R 4/2011 (VA), which lays down rules for investments by German insurance companies. It incorporates numerous changes resulting from the revisions of the investment directive and BaFin's communications published since 2005 and came into force on 1 June 2011. Detailed requirements for the first time As they constitute "special rules", the requirements in the new investment circular take priority over those in BaFin's circular on Minimum Requirements for Risk Management (No. R 3/2009 VA) and are considered to be in anticipation of the Solvency II regulations, which will apply from 2013. In the investment circular, BaFin for the first time clearly defines the requirements of an asset-liability management function in detail. The crux of the requirements is that every insurance company should develop a strategic investment policy suited to its particular lines of business and business models and integrate the ALM process into its monitoring and control system. The objectives of ALM are to be derived consistently from the requirements laid down in the risk strategy. All significant risks on both the assets and the liabilities sides of the balance sheet must be included, the causes of risk identified and their interactions with each other determined. In addition to historical data, the forecast future development of key factors such as the capital markets and new business must be taken into account. The ALM methodology used for the analysis must be in line with the size and degree of complexity of the insurance company and the type of technical provisions it has. The following steps must be taken to perform the analysis: First, the objectives and performance measures specific to the company must be defined, as they form the basis for the further work. Then, the causes and interactions (for example for market, underwriting and liquidity risks) must be identified.

A forecast of future developments in the company's economic environment (e.g. capital markets, new business, changes in the cash-flow profile) should then be produced. Finally, the market risk must be quantified using ALM methods, taking account of changes in interest rates, stock markets, property markets and currencies for a series of time horizons. The results, together with the associated options for action and recommendations, must then be presented to the Board member responsible for managing and covering the risks identified. All assumptions should be clearly documented so that subsequent actuals/ forecast comparisons can be used to identify any errors in the forecasts. A complex challenge for insurers BaFin's requirements apply not only to life insurers, but also to health and property-casualty insurers. They are very specific and cover both the content of ALM and the processes involved. Meeting them will be a complex task. Even in property-casualty insurance, where so far little attention has been paid to ALM, many companies will need to create appropriate processes quickly. Insurance companies can obtain support from outside to help them meet the requirements, and in its investment circular, BaFin states expressly that it is possible, and permissible, for ALM to be outsourced completely to other companies, though responsibility will always remain with the insurance company's board. Our expertise Munich Re has been practising ALM for many years, over which it has developed a particularly high level of expertise. Thanks to our sophisticated asset-liability management, our clients can rest assured that we always meet our performance commitments ­ in both the short and the long term. Indeed, we have long geared the management of our own investments closely to the structure of the liabilities in our balance sheet. Our ALM includes determining a synthetic investment portfolio that reflects as closely as possible the characteristics of our insurance liabilities. Responsibility for this lies with our Asset-Liability Management Division, where we have concentrated our expertise. We are also always pleased to use our experience to help cedants to develop and improve their own asset-liability management.

MUNICH RE Topics Magazine 2/2011


Our solution: ALPHA

ALPHA ­ "Asset Liability Portfolio Hedge Administration" ­ is a service we offer to non-life insurers. We work with our clients step by step to design a tailor-made solution for asset-liability management based on our liabilities-driven investment process: 1. A detailed analysis of your loss data gives a precise picture of the loss reserves and run-off patterns. 2. An economic valuation of the technical provisions is performed as a basis for asset-liability management and risk measurement. 3. The replicating portfolio shows you what investments to use to minimise market risks. It is investable and also serves as a basis for risk measurement. 4. It is used to derive a benchmark portfolio for managing the actual investments, taking account of restrictions and strategies as required. The aim is to incur market risks in a controlled manner in order to generate higher returns. All of the tools required are run at Munich Re, avoiding any need for time-consuming software implementation on site, thus keeping costs to a minimum for the client. Our experts, who are also responsible for Munich Re's own internal investment process, are available to assist you.

The modules in the ALPHA process chain Loss data, run-off patterns Economic valuation Replicating portfolio Benchmark portfolio, investments

We carry out a detailed analysis for each step in the process, producing comprehensive ALPHA reports on reserves, run-off patterns, risk factors, replicating portfolios and benchmark portfolios tailored to your company's requirements.

Using ALPHA (see diagram above), they can go through our ALM process, thus profiting from our practical experience, tried-and-tested tools and processes, and support from competent specialists. Our ALPHA Team can provide the specialist knowledge needed to carry out ALM analyses. Why not contact our experts to talk about your needs?

OUR EXPERTS: Bernd Proeller is a Senior Consultant in our Asset-Liability Management Division. [email protected]

Rainer Stragies is Munich Re's ALPHA Project Manager in the Asset-Liability Management Division. [email protected]


MUNICH RE Topics Magazine 2/2011


"Other countries in the EU should follow BaFin's example"

Professor Karel van Hulle, Head of the Insurance and Pensions Unit at the European Commission, talks about the motivating effect of the German asset-liability management requirements.

Since 2004, Professor Karel van Hulle has headed up the Insurance and Pensions Unit at the European Commission, where he is also heavily involved in international harmonisation efforts.

Topics: In its new investment circular, BaFin has laid down detailed requirements for asset-liability management (ALM) at all German insurance companies. Can we assume that, in anticipation of Solvency II, other European countries will also introduce more explicit regulations for ALM processes? Karel Van Hulle: ALM is a fundamental part of a risk-based solvency regime. Particularly in today's environment with highly volatile markets, it is important for insurance undertakings to ensure through good assetliability management that they will be able to honour the guarantees they have given as and when they fall due. I would hope that supervisors in other member states will follow the example of BaFin in urging companies to improve their ALM.

Will there then also be precise requirements for ALM at European level that apply to every insurance company? On the basis of the Level 2 implementing measures for Solvency II, EIOPA will develop binding technical standards and additional (non-binding) guidelines. As the rules will be the same in all member states, it will be easier for supervisors in the EU to define best practice based on those rules ­ including for ALM. In Germany, insurers are allowed to outsource ALM. What is the position at European level? The Solvency II framework directive permits insurance companies to outsource a number of activities to external providers. This includes ALM, though responsibility remains with the company's management and supervisors can perform audits to ensure that ALM is being properly carried out.

Have requirements for providers of ALM services already been formulated at European level? There are no specific qualifying requirements set at this stage, but EIOPA may decide to introduce some. External ALM services should be subject to the same requirements as internal processes, as the ultimate goal is to ensure that the institution is solvent and in a position to meet its obligations to its policyholders. I would expect the basic requirements to be the same in all member states, though there could be variations due to subsidiarity and proportionality.

MUNICH RE Topics Magazine 2/2011



Safer than safe

Under Solvency II, the default risk on all business partners will be taken into account in the calculation of risk capital. But is collateralisation of reinsurance recoverables really worthwhile for cedants?

Astrid Beigel and Dr. Katja Lord

The EU's new supervisory regulations will come into force on 1 January 2013. Solvency II poses an enormous challenge for the insurance industry with its requirement that, for the first time, companies will have to measure all of the risks they incur. Apart from underwriting risk, they will need to take into account market, counterparty default and operational risks to determine their risk capital requirement and will only be able to do this if they have an in-depth understanding of all of their risks and the interdependencies between them. Only if they achieve this will it be possible to use risk-reduction measures to add value. In the context of counterparty default risk, which will have to be measured in future, the question arises as to whether the collateralisation of reinsurance recoverables will actually be worthwhile for cedants. Counterparty default risk will be taken into account in several places Counterparty default risk refers to the risk of a business partner or reinsurer no longer being able to meet its payment obligations, such as commissions or loss reserve payouts, in full. This risk must now be taken into account at various points in the annual calculation of a company's solvency ratio. To determine the available capital under Solvency II, all items in the balance sheet must be valued from an economic perspective, i.e. wherever possible at market or market-consistent prices. The "expected" loss on default of the reinsurer must be included in the valuation of the reinsurance recoverables on the assets side of the economic balance sheet, which ultimately

has the effect of reducing available capital. Other effects from the risk margin are disregarded. The counterparty default risk must also be taken into account in the calculation of the risk capital required to be held under Solvency II: all of an insurer's recoverables from its reinsurers must be covered by risk capital in order to enable it to withstand even an "unexpected" default resulting from a two-hundredyear event. Risk capital for the default risk on reinsurance recoverables To calculate the risk capital for a potential loss on the reinsurer, it is necessary to estimate the loss that would be incurred were the reinsurer to default (loss given default, LGD). Under Solvency II, the assumption is made that a reinsurer would be able to meet 50% of its liabilities even on insolvency. The fact that the solvency relief effect provided by the reinsurance treaty would fall away in an insolvency must also be taken into account. Furthermore, the reinsurer's default probability, which, according to the current state of the debate, will generally within the EU be based on its solvency ratio, is also included in the calculation of the risk capital requirement. Risk-reduction measures help to reduce a company's risk capital requirement (solvency capital requirement, SCR), thus improving its solvency position.


MUNICH RE Topics Magazine 2/2011


The financial strength of a business partner has a significant effect on risk capital requirements.

For a cash deposit, the economic value of the risk capital relief will be a small single-digit percentage of the reinsurance recoverables assuming the risk capital costs usual in the market. The insurer will normally place the cash deposit with a bank, thereby increasing its default risk on the bank by the same amount (see Fig. 1). With a securities deposit, risk capital relief will be in the low single-digit percentage range as well. If, however, the insurer covers reinsurance recoverables in the capital markets, only a half of the recoverables need be covered, rather than 100%, since the insurer is assumed for Solvency II purposes to receive a half of its reinsurance recoverable as an unsecured creditor if the reinsurer becomes insolvent (see Fig. 2 on page 30). Negligible risk capital relief Thus, with collateralisation, default probabilities can be exchanged, and in many cases it enables diversification to be improved by spreading the risk across several business partners and modest reductions in the risk capital requirement can be achieved. However, as the cost of collateralisation generally exceeds the economic value of the risk capital reduction, from an economic perspective the insurer derives no overall benefit from collateralising reinsurance recoverables.

Forms of collateralisation There are various possibilities open to insurers for securing their reinsurance recoverables. The most common ones are: ­ a letter of credit (LoC), effectively an external bank guarantee for the amount recoverable; ­ a cash deposit placed by the reinsurer with the insurer, often referred to as "funds withheld"; ­ a securities deposit at a bank held to the order of the insurer. In principle, the insurer can also cover the risk of reinsurer default in the capital markets, for example by purchasing credit default swaps (CDSs). Under Solvency II, recognition of the different forms of collateralisation will vary. The current position with LoCs is that the default probability for the reinsurer will merely be replaced by that for the guarantor.

Fig. 1: Default risk with or without cash deposits as collateral


Default risk on bank Default risk on reinsurer Reinsurance treaty





Left: If there is no collateralisation, the reinsurer default risk is of relevance. Right: If collateralisation is by way of cash deposit, the insurer has a default risk on the

bank. Overall, therefore, the insurer merely exchanges default probabilities. Source: Munich Re

MUNICH RE Topics Magazine 2/2011



Fig. 2: Amount of collateralisation required ­ reinsurer versus capital markets

Collateral provided by reinsurer

Were the reinsurer to become insolvent, partial collateralisation of recoverables would reduce the claim on the reinsurer and hence the amount recoverable as an unsecured creditor.

Collateral provided by a third party (e.g. via the capital markets)

Were the reinsurer to become insolvent, additional collateralisation through the capital markets would not be applied in reduction of the insurer's claim as an unsecured creditor of the reinsurer.

50% cover for claims INSURER 100% cover for claims COLLATERAL INSURER


50% cover for claims

The default risk can be totally eliminated in either case, but the amount of collateral required and the associated transaction costs differ.

On the left, full collateralisation is required, on the right only 50% collateralisation. Source: Munich Re

Business partner's solvency ratio is of key importance Analyses have shown that it is a business partner's financial strength that has the greatest effect on capital requirements. Thus, the reinsurer's default probability (based on its solvency ratio) is the only decisive factor and should be compared to that for a bank. Consequently, in the context of the Solvency II risk capital calculation, there is no need for collateralisation for a strong financial partner and Munich Re's strong balance sheet means that for our cedants, any positive solvency effects derived from collateralisation are too small relative to the additional costs involved (e.g. transaction costs). It is more important to concentrate on rigorous risk management, as making risks, and hence the business, transparent enables a company to make optimum use of its capital.

OUR EXPERTS: Astrid Beigel, a qualified mathematician and member of the German Association of Actuaries, is a senior underwriter and deals with the structuring of reinsurance treaties across all lines of business. [email protected]

Dr. Katja Lord, a qualified mathematician and member of the Swiss Association of Actuaries, is responsible for consultancy services provided to operational areas by Munich Re's Solvency Consulting unit. [email protected]


MUNICH RE Topics Magazine 2/2011

Is your business geointelligent enough?

Modern integrated risk management requires a detailed knowledge of geographical environment. Munich Re's NATHAN (Natural Hazards Assessment Network) Risk Suite optimises your assessment of natural hazard risks, from entire portfolios down to individual risks at address level ­ worldwide. OUR SOLUTIONS ­ YOUR SUCCESS NATHAN Risk Suite offers a range of advantages: ­ Knowledge of individual locations for tailor-made rating ­ Greater transparency of complexities ensuring clear-cut decisions ­ Increased knowledge providing an optimal spread of risks For further information, please contact your client manager or go to



New ideas are our trade

Life insurers today operate in highly competitive markets in many different regions. As a growth engine for new business, product development therefore plays a particularly important role in ensuring long-term profitability and competitiveness.

What happens when people lose their capacity to work? The German disability insurance concept may well become an international model, too.


MUNICH RE Topics Magazine 2/2011


Patricia Takes

"How can I safeguard my standard of living if illness prevents me from working in my present occupation?" A worrying question for many working people in Germany, as the state social insurance system only provides assistance in cases of general occupational disability. In other words, if a working person is unable to take up any gainful work on account of illness, the state will pay a monthly pension related to the person's last earnings. The situation is very different, however, if someone is merely unable to continue his or her present occupation on account of an allergy, for example, or can only work in that occupation to a limited extent but is still basically able to work. Such cases are not covered by the social insurance system. To fill this gap in personal care, German life insurers offer a unique solution in the form of "own occupation" disability insurance. Fierce competition for the best risks Roughly 20% of all employed and self-employed people in Germany make use of this opportunity to provide for their future. Around 100 insurers are competing in the disability insurance market. The quality of their products and the benefits they offer have already reached the limits of what is reasonable and feasible, and are now very similar. As a result, competition for the best risks, i.e. policyholders with a particularly low occupational risk, has mainly been pricedriven for several years now. This trend can be observed in many life insurance market sectors today. Unless a player wants to stand idly by and watch its profit margins dwindle, new products are an essential way to stand out from the crowd. A decline in new business will otherwise be all but unavoidable, as one leading provider of disability insurance products discovered to its cost. Despite getting top marks from all the main rating agencies, it was rapidly losing favour among applicants on account of the general trend in prices. Its disability insurance tariffs for a number of particularly low-risk occupations were more than 30% more expensive than those of the cheapest competitor. This trend had to be reversed without delay. In this case, the insurer's strategic product development goal was "Top conditions for top policyholders". The company hoped to bounce back as one of the five leading providers, acquiring new business that would boost its market shares among the best risks ­ and preferably as soon as possible. The risk philosophy and strategic orientation were to remain untouched. Due to the prevailing consumer price sensitivity, the concept would need to ensure disability insurance tariffs which were commensurate with the risk and hence profitable in the long term.

Differentiated view of the individual risk As usual in the German disability insurance market, the primary insurer had hitherto based its rating on a traditional system of fixed occupational and tariff classes, with applicants being assigned to a specific category on the basis of the job they carried out at the time the application was submitted. In order to offer selected target groups more advantageous terms, some competitors had established a so-called stepup system, for which applicants had to provide additional information, such as qualifications, personnel responsibility or amount of manual labour involved. In most cases, a positive criterion, such as the answer "graduate", automatically resulted in an improved classification for the applicant. This is a first step towards improving the individual assessment. However, the accuracy of the risk assessment is enhanced when positive and negative factors are considered in relation to one another and weighted. Studies by Munich Re have also shown that, with a view to the portfolio as a whole, the statistical probability of occupational disability occurring is not the sole criterion of importance for risk assessment. The duration of disability also plays a key role. All these findings had to be taken into account along with the primary insurer's specific requirements when developing the product. It soon became clear that a standardised system of occupational classes, such as that used in the past, could not prove successful if it were merely reorganised according to market needs. Collaborating with the primary insurer, we therefore began to develop a system that would permit a more differentiated assessment of the risk according to individual criteria. Risk-commensurate classification makes for more attractive terms The new system takes account of numerous factors: when applying for insurance, the applicant must provide information on a number of objective, sociodemographic and job-related risk factors. The answers are evaluated with the aid of a weighted merit-rating system. A positive criterion, such as "graduate", can consequently be enhanced through additional positive answers or downgraded due to the existence of negative criteria (see Fig. 1, page 34). The basic structure of the insurer's existing occupational class system was essentially retained, but expanded to include specific occupational subclasses. As a result, the occupational risks can now be assessed and differentiated much more clearly. Attractive target groups can be offered more advantageous terms.

MUNICH RE Topics Magazine 2/2011



The results speak for themselves: the new system of occupational classes was introduced within a few months and smoothly integrated, thanks to extensive discussion with all relevant departments at the insurance company. Within the space of just one year, all the project objectives had been achieved: in new business, the insurer reported a considerable increase in market shares and was able to reclaim its leading position. Integrated product development approach Even with optimum data resources, this kind of product development cannot be achieved using purely actuarial methods. The project owed its success to our extensive occupational know-how. Munich Re also has access to most of the biometric data available in this segment. In the German life insurance segment alone, we implement some 30 projects of all sizes each year. Client proximity, a detailed knowledge of the market and first-class data resources provide the foundations for successful product development. We pursue an integrated product development approach so that the know-how and competence of our highly specialised experts can be employed efficiently and purposefully.

A mutual understanding of the objectives is an import ant aspect of this. To this end, we first sit down with the primary insurer and jointly analyse the present situation in a structured workshop. What are the project's strategic goals? What is the company's risk philosophy? Which market-related and basic organisational conditions apply, from underwriting practice through the portfolio structure and target groups to IT and sales? How soon must the new product be implemented? All the primary insurer's relevant interest groups are involved, right from the very first phase. The outcome is a clear catalogue of requirements for the product development project. The client manager responsible for the primary insurer plays a fundamental part here. In many cases, he or she has known the client's company, its structures and risk philosophy for many years and is therefore responsible for coordinating collaboration. Munich Re experts from various disciplines are consulted in specific cases, depending on the development objective. The team responds very flexibly to the primary insurer's individual requirements, purposefully advancing the progress of the project. Each product development passes through a defined sequence of project phases and is subjected to ongoing systematic investigation. In this way, deadends can be recognised early on and development errors stopped in good time (see Fig. 2).

Fig. 1 Occupational know-how combined with loss experience An assessment based purely on occupational classes will not suffice to ensure commensurate rating. The different factors must be considered together and weighted. Individual loss experience Source: Munich Re


Positive risk factors

­ ­ ­ ­

Positive future prospects High expected income High recognition and motivation Professional career

BASIC ASSESSMENT OF THE OCCUPATION ­ ­ ­ ­ ­ Physical stress Accident risk Psychological stress Psychosocial risk factors Special demands

Negative risk factors



MUNICH RE Topics Magazine 2/2011

Fig. 2 Schematic illustration of a product development To maximise efficiency, product development always follows a similar pattern. This ensures that development errors can be recognised as quickly as possible.



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Source: Munich Re




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Innovation based on global knowledge transfer Life insurers in other markets could soon also profit from the experience gathered in the project outlined above, particularly since occupational aspects have hitherto barely featured outside German-speaking countries. The global transfer of knowledge in product development is one of our strengths. The prospects this offers in practice are best illustrated by the example of China's third-largest life insurance company. The China Pacific Life Insurance Company (CPIC) planned to introduce whole life insurance with profit sharing modelled on the British system. Such a concept was unknown in the Chinese market until then. The planned new product was to offer a longer insurance term and greater protection than the established products. CPIC enlisted Munich Re as its product development partner ­ particularly for modelling the commission structures, profit testing and for developing the underwriting principles and benefits. Munich Re contributed its extensive experience of the British market, and the ensuing product, which was promptly developed in collaboration with CPIC, features a continuous increase in capital and a high terminal bonus ­ and is rounded off by a critical illness rider. This innovative product was introduced in 2009 and became a best-seller for CPIC within the space of a few months.

Product management ­ a factor for success Continuous product management is crucial to the long-term success and added value of a newly developed product. Munich Re also plays an active part here, yielding two advantages for the primary insurer: on the one hand, regular biometric analyses of the portfolio help to pinpoint potential for optimisation and avoid development errors. Secondly, our involvement is a clear commitment to long-term collaboration. Munich Re does not charge any direct fee for its product development work and the subsequent product management services. A quota share agreement is concluded instead. In the case of CPIC, Munich Re Beijing Life receives a quota share on a coinsurance basis for the critical illness rider, as well as a share of the main product on a risk premium basis for the death benefit. This ensures that the interests of the two partners are aligned and the primary insurer develops a product with minimal investment risk.

>> Further information on our services in life insurance can be found here:


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OUR EXPERT: Patricia Takes, a mathematics graduate and a member of the DAV (German Association of Actuaries), is a Senior Client Manager at Munich Re and responsible for product development in Germany and Switzerland

MUNICH RE Topics Magazine 2/2011 35


"We want to grow with our clients"

Topics discusses the challenges involved in product development projects with Rudolf Lenhard, Head of International Life Business, and Klaus Wolf, Head of Client Management for Germany and Switzerland.

Topics: Mr. Wolf, as a client manager, you are constantly in contact with life insurance clients. Where do you see the greatest need for action and development? Klaus Wolf: There are vast regional differences here. The main issues in the German market today are the newly defined maximum actuarial interest rate and its consequences for endowment business. In addition, price competition is escalating, for instance in the disability insurance sector. This is why many companies are looking for ways to distinguish themselves from the competition. Rudolf Lenhard: Supra-regional requirements, such as unisex pricing which is set to become mandatory throughout the European Union, are another key concern. This calls for action from all market players. Which of Munich Re's competences do clients call on? Lenhard: A major aspect in many regions is the introduction of innovative products which have yet to gain a foothold in the market. This is where we can contribute our international experience and create added value through the global transfer of knowledge. And wherever necessary, we also draw on our knowledge of non-life or health insurance business, for instance when developing products for long term


care insurance or products which combine elements of life insurance with elements of personal accident insurance. Wolf: Our biometric know-how is particularly in demand, especially in terms of pricing and risk assessment but also as regards the product benefits. We are also called in to develop new sales channels and to improve the processes for new business. Which factors make for successful product development, in your experience? Lenhard: Mutual trust, a spirit of partnership and open dialogue are important when working together. The more the cedant tells us, the better we are able to understand the challenges involved. And vice versa. We require a detailed knowledge of the market concerned, as well as an analysis of the cedant's strategy and objectives if product development is to be successful. Both parties, i.e. the primary insurer and Munich Re, must develop a common understanding of the project. Wolf: Many aspects play a role in product development: from the target groups and sales channels to the degree of product complexity permitted, for example with regard to tech-

nical parameters or existing operational and sales processes. On the basis of this understanding, we assemble an individual development team comprising experts who work in the specific market and others who operate on a supra-regional level. In this way, we can make targeted use of the expertise required. This integrated approach is our key to customised product development. Who are these experts? Wolf: Actuarial expertise plays a crucial role in pricing, but it is not the only important factor in product development. Where necessary, we also involve risk assessors and claims, legal, medical and vocational specialists. Such experts are on hand in Munich Re's service units, encompassing a depth and breadth of specialist knowledge that no primary insurer could ever match. It is this holistic approach that sets us apart. Mr. Lenhard, Munich Re's actuarial know-how is concentrated in your department. How do the clients benefit from this? Lenhard: The Actuarial and Innovative Solutions team is made up of international experts who are fully familiar with the latest methodologies and contribute detailed actuarial know-how. This is essential for risk-commensurate product pricing

MUNICH RE Topics Magazine 2/2011

Rudolf Lenhard (left) and Klaus Wolf.

and in achieving an actuarially sound product design. As a central service unit, we provide this service for markets around the world. This enables us to identify trends at an early stage, link up ideas and apply existing know-how to local markets. As a result, clients' requirements can be met more quickly and costly duplication of work is avoided. How is the collaboration between client, client management and the experts organised? Wolf: That depends on the requirements. Our central interface is always a client manager or project manager who cooperates closely with the team of experts. However, this collaboration is closely meshed on all levels. Our experts communicate directly with the specialists in primary insurance or provide their services on the spot, sometimes even working in the cedant's departments on a long-term basis.

Is there such a thing as a typical, ideal product development process? Lenhard: No, there isn't. We have our set of tools, of course, and we also make use of tried-and-tested components, but we operate very flexibly and always as required. At most, we have a general outline that we stick to. The first step is to define an idea that matches the client's strategy. Then we develop a concept for two or three product ideas. When a decision has been reached, the business case is then developed with expected profit and earnings. This is then implemented by the cedant, with training for the office staff and field staff. That sounds like a great deal of work involving a lot of people. Does this mean that product developments with Munich Re are only worthwhile for the big primary insurers? Lenhard: Mastering a challenge always demands a certain amount of effort. The question must be whether working with us requires more effort than working without us. The answer to that is no. With Munich Re, primary insurers have an experienced partner with a track record of mastering similar challenges. But there is also something else: product development can be scaled; it can be complex or lean. In the end, this depends on the starting point and on the objective. What's more, product

development is essential in order to remain competitive in the long term. It need not be a major innovation every time: what we need is to keep the products in line with market needs ­ and that can be achieved with a justifiable amount of effort. Wolf: Motivation is an important point here. For us, product development is not an end in itself: our primary aim is to help our clients to grow. We assist primary insurers because we want to grow together with them through our share in the reinsurance business. Munich Re also contributes to product management after the development stage. What advantages does this bring for the client? Lenhard: Bearing the risk is part of product management and our core business. We also conduct biometric portfolio analyses for our clients, for example, and compare the claims experience with the market. The resultant indicators enable us to respond and make adjustments promptly, working together with the client. This serves the interests of both parties and encourages a dynamic long-term partnership.

MUNICH RE Topics Magazine 2/2011



When treatment becomes a risk

Even the best physicians are not immune to making mistakes. Claims expenditure is rising disproportionately. Yet this sector offers significant growth potential worldwide if it is handled professionally.

Michael Janisch

In the past, doctors were frequently known as the "gods in white coats" ­ an ironic epithet with a serious point, as decisions by medical professionals were rarely or never questioned. Lawsuits based on medical malpractice were extremely rare. This has changed over the years. Throughout the world, there are more and more press reports on "bungling in hospitals" and suits filed against medical professionals have long ceased to be a rarity. And this has implications ­ also for the insurance industry. Which global trends can be identified in medical malpractice (MedMal) insurance? Which opportunities and risks arise for the insurance industry? Statistical data are more or less unavailable, both nationally and internationally. As a result, the world market can only be estimated very roughly. The largest MedMal market ­ the USA ­ recorded an estimated premium volume of around 8bn (US$ 10bn) in 2009. The US share of the worldwide liability market is around 50%. If that share is now applied to MedMal, this would mean that the worldwide premium volume is currently in the order of about 16bn.

There are several signs indicating that we have by no means reached the end of the line in terms of volume. In the emerging markets, for instance, supply standards and demand for medical treatment are rising constantly. And patients` claims mentality is increasing at the same time. This trend is currently emerging in many countries of Latin America, for example. In more highly developed markets, the healthcare sector is growing at a much slower pace, but victims are increasingly being backed by court rulings and the amount of damages awarded is soaring to unprecedented heights. This creates numerous opportunities for the private insurance industry to satisfy the patients` desire for damages on the one hand, while satisfying the professionals` need to cover the treatment risk on the other. However, basic cultural and legal conditions must be closely scrutinised at the same time.

Ask your doctor about the risks and side effects? It is up to doctors to provide information on the possible risks before undertaking any kind of surgery. MUNICH RE Topics Magazine 2/2011 39


Interesting opportunities are sure to be available in the highly populated emerging markets, if only on account of the large number of potential policyholders. In China, for instance, there are 1.86 million doctors as compared to 0.73 million in the USA; this is equivalent to 26 doctors per 10,000 inhabitants in the USA but only 14 for the same number in China. This ratio will increase if the economy continues to develop as at present. Chinese MedMal premium for 2008 was estimated to be well under 100m or less than 1% of the world market. Recent years, however, have seen a number of major changes, all indicating a growing demand for insurance in China. Liability has been transferred from the state to the hospitals and in large development centres, such as Beijing, Shanghai and Shenzhen, compulsory insurance has been introduced for hospitals. An expanding economy, growing prosperity, urbanisation and a higher level of education among the urban population are making people more willing to invest in medical treatment; at the same time, their readiness to take court action is also growing.

The situation is similar in many other countries too, such as Russia, or India and Brazil, where lawsuits are already more common. In India, legislation to protect consumers made it much easier to bring action against physicians as far back as 1986. Roughly one-third of the world population lives in countries which qualify as "lower middle income". These countries` populations are relatively young on average and comparable developments must be expected as affluence increases (see Fig. 2). In short, there is significant potential for growth in MedMal insurance. However, this potential greatly depends on the economic development of the country concerned, as well as on its liability law and how the insurance market is organised. A neat statistical appraisal of the risk, and expertise in risk selection as well as in risk management and claims handling, are consequently indispensable to the success of any insurer seeking to operate in this segment.

Fig. 1: Medical care in countries with different average incomes Population in 1,000 Total Low income countries Lower middle income countries Upper middle income countries High income countries Global Source: WHO, 2006 2,470,318 2,295,036 817,293 998,238 6,580,921 Age Average Under 15 in % 22 30 30 38 28 36 25 25 18 28 Over 60 in % 6 10 12 20 10 Medical care Doctors 1,163,269 2,894,455 1,673,117 2,682,262 8,413,147 Per 10,000 inhabitants 5 13 21 28 13

­ The greatest potential for growth is to be found in the "lower middle income" segment, which includes China, India and Brazil. ­ The 35% of doctors worldwide who work in this segment have a growing need for insurance. ­ The density of medical treatment available in this segment is around 60% of the "upper middle income" group; the absolute number of doctors (and consequently the need for insurance) will increase.


MUNICH RE Topics Magazine 2/2011


Fig. 2: Do "lower middle income" countries offer business opportunities? Per-capita income (in US$) 14,000 South Africa 12,000 10,000 8,000 6,000 4,000 2,000 0 0 50,000 100,000 150,000 200,000 250,000 Number of doctors Philippines Vietnam Bangladesh Pakistan Egypt Source: WHO Mexico Income and the density of treatment are possible demand triggers. It is impossible to generalise, however, as the countries are not homogeneous and the market potential depends very strongly on legal and cultural conditions. Density of treatment

Iran Thailand



Socio-political components To a much greater extent than many other lines of business, medical malpractice insurance and health insurance are caught in the middle between public interest and dynamic claims development. The latter results in higher indemnification by the insurers and consequently a need for ever higher premiums. A smoothly functioning healthcare system is a matter of primary interest for every state and is also a state responsibility. Last but not least, this responsibility also means ensuring that medical treatment is backed by suitable liability insurance. For the insurance industry, the long-term assessability of the basic financial data is a primary concern, this being the prerequisite for making risks calculable. Policyholders want stable and affordable premiums while the victims of medical malpractice expect adequate compensation. The more dynamically developments progress in individual countries, the more difficult it will be to take account of all interests.

This is illustrated by a closer look at some markets. The United Kingdom, with its essentially state-organised National Health Service providing free medical treatment for its citizens, is an exception in the AngloSaxon world, which otherwise tends to favour liberalisation. Doctors employed by the National Health Service are vicariously liable based on fault. Most lawsuits, however, are addressed directly against the National Health Service Trusts and health authorities. Recourse against the party actually causing the damage is excluded. The trusts are insured through a payas-you-go fund in the Clinical Negligence Scheme for Trusts. In recent years, France has repeatedly faced demands by doctors who were no longer willing to pay the high insurance premiums resulting from claims inflation and the withdrawal of several foreign insurers. The French state responded in 2002 by introducing faultbased liability, compulsory insurance and obliging insurers to enter into contracts. Serious injuries without fault (accidents médicaux), including infections acquired in hospital and resulting in a degree of disability of at least 25%, are indemnified by the state through the Office National d`Indemnisation des Accidents Médicaux (ONIAM).

MUNICH RE Topics Magazine 2/2011



Special case: Perinatal injury

Cover of perinatal injury and the professional groups directly involved in childbirth is a potential nightmare for every MedMal insurer. Newborn babies can sustain serious bodily injuries requiring lifelong nursing care.

Perinatal injuries are among the largest and most complex claims confronting a MedMal insurer. Such claims tend to be high, if only on account of the maximum duration of nursing care needed. In most developed markets, the number of such claims appears to be relatively stable, but their inflationary nature makes them a major cost factor. Besides which, it can take over twenty years to resolve such claims, depending on the legal system concerned. In many countries, the claim is only finally settled in court when the victim comes of age and this can then be followed by payment of lifelong annuities. Serious perinatal injury can cost up to 15m in Europe today.

The total loss burden is carried by a relatively small number of premium payers (see Fig. 3). This results in insurance premiums which are difficult to afford for the individual insured. The "midwife cover", a group insurance for midwives for which massive premium increases were demanded, is one recent example from the German market which received emotive coverage in the press. This is not the place to speculate on what might be the "right" premium. Instead, we are looking for alternative solutions leading out of the dilemma of inflationary claims and spiralling premiums.

An interesting first-party cover has been developed in Japan. Although this personal accident insurance currently only covers part of the overall loss, this example does illustrate a means of effectively sharing the premium burden. The Obstetric Compensation System for Cerebral Palsy was set up in 2009. Almost all Japanese hospitals have joined the system. Cover is based on personal accident insurance. Parents pay a single premium of 30,000 yen (approx. 300) per birth when they claim the services provided by a hospital. If their child then incurs cerebral palsy, the insurance pays a lump sum of 6 million yen (approx. 60,000) as well as an annual pension of 1.2 million yen (approx. 12,000) until the child reaches the age of 20. The system's objective is to relieve all parties, but also to ensure that all cases of injury

Arbitration tribunals where the victims of medical malpractice could seek recourse were set up together with the ONIAM. The aim was to compensate victims quickly and in keeping with their needs, without first having to take court action. Although many of the insurance industry's demands had been met ­ particularly the clarification of liability and the introduction of "claims made" as the basis underlying compulsory insurance ­ higher premiums were unavoidable due to sustained claims inflation. And once again, the state promised its support, with subsidised insurance premiums to meet the doctors' demands. At present, it is planned to introduce a pool financed by contributions from all medical professionals to cover major losses.

Different answers have been found to comparable problems, as a look across the Atlantic shows. Almost all Canadian doctors are members of the Medical Protective Association (CMPA), a mutual association granting unlimited cover which is subsidised by public funds. A number of US states sought to control ever higher damages by reforming their tort law. Among other things, they sought to impose "caps" limiting the nonpecuniary damages awarded. Since then, however, supreme courts in a number of states have ruled that these caps are unconstitutional. The US Congress is still debating over a national Help Efficient, Accessible, Low-cost, Timely Healthcare (HEALTH) Act of


MUNICH RE Topics Magazine 2/2011


Fig. 3: Does the law of large numbers apply? The relatively small number of policyholders and the few, yet expensive claims present a challenge for MedMal insurers. Policyholders Motor claims Perinatal claims Source: Munich Re

are publicised and the causes leading to the damage clarified more efficiently. In the Netherlands, a system has been established on the basis of the so-called "Convenant", which excludes recourse by social security institutions seeking to recover care costs in individual cases and instead allocates the care costs to all insurers involved (99% of the market) within the framework of an agreement concluded for periods of three years at a time. Because the system is borne by all liability insurers as a whole (and applies for all types of liability claim), it relieves the burden on the MedMal insurers, for whom perinatal injuries can now be estimated more effectively ­ with direct effect on premiums.

The Scandinavian countries have gone one step further with their "nofault schemes" developed in conjunction with legislation on patient rights. Access to compensation has been made vastly simpler for the patient. The financial burden is borne by the community through public financing. The compensation schemes cover all medical services, including perinatal injury. The most radical solution is no doubt to be found in New Zealand, where ­ since the Accident Compensation Act of 1972 was introduced ­ bodily injury of every kind is indemnified as a matter of principle through a statefinanced programme, without clarifying the question of liability.

This also includes bodily injury sustained through medical treatment (Treatment Injury Account). However, the question which arises is whether, in the interests of solidarity and spreading the loss burden across many shoulders, one solution in the classic liability markets might be to calculate premiums on a broader foundation, so that the statistical basis is enlarged to include all or several medical disciplines instead of only those associated with childbirth. The French pool solution could serve as a model in this respect.

2011. The agenda includes limits for non-pecuniary losses, performance standards for state-owned medical facilities and improvements in patient safety, as well as other issues. Moreover, doctors and hospitals have in some cases turned their back on the traditional providers of insurance and formed so-called "risk retention groups" or captives. These now have around 100,000 members. US healthcare reform poses a new challenge for the medical malpractice market, as its consequences are difficult to judge at present. The effects could be both positive and negative. On the one hand, medical problems could be detected at an earlier stage, as many patients without health insurance currently only

receive treatment at the very last moment in emergency rooms; this would reduce exposure to liability. If health insurers were to bear the costs, fewer lawsuits could be filed on account of extended stays in hospital as a result of medical malpractice. On the other hand, the number of patients could increase sharply when compulsory insurance is introduced, particularly during the first phase ­ the number of patients is expected to rise by up to 20%. This, in turn, could lead to a higher number of claims, especially if the number of doctors does not increase accordingly and nursing staff have to take over some of the activities normally performed by doctors.

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Legal trends The days in which it was almost inconceivable that a doctor could be sued for malpractice are long gone. "The subject of patient safety was completely taboo only ten years ago", says Professor Christian Lackner of Munich University`s Institute for Emergency Medicine (see the following interview). Even among doctors, a more conscious attitude towards errors and a growing awareness of mistakes have become a largely accepted part of their working environment today. Many fundamental issues relating to medical liability have been placed on a new footing or clarified by the legislature or by court practice in the developed European and Anglo-American legal systems. In the majority of cases, attention has focused on the burden of proof: court practice in Germany, for example, reverses the burden of proof for certain facts, while clearly upholding the principle of fault. Among others, these include "lacking or inadequate information for patients", "grave errors in treatment", i.e. errors which are incomprehensible from an objective medical viewpoint or which violate elementary rules of medical practice, as well as disregard for the "duty to keep records". Ever higher damages, particularly for serious bodily injury, are a matter of great financial importance for the insurance industry. In the German market, expenditure for serious bodily injury has risen by almost 10% in recent years. This figure is well above the normal level of inflation. It is primarily attributable to the rising cost of nursing care, which accounts for more than 60% of the total indemnification on average. Yet Germany is not alone here, as the UK and France are experiencing a very similar development. This is due to a growing awareness of the need for nursing care, generally rising demand for nursing services as a result of demographic developments, and because families are increasingly less able to look after their sick or elderly members themselves.

Financially straitened social security systems have also heightened awareness of the possibility of seeking recourse against liability insurers. The French Conseil d'État issued an interesting ruling in this context in 2008 (No. 235887 dated 25.6.2008): according to standard practice, the indemnification paid for bodily injury is based not only on lump-sum payments, for instance for treatment, but also on a fixed index-linked annuity for recurrent services (especially care costs). The aforementioned ruling departed from this standard practice: in those cases in which underage victims are nursed both at home and in a stateowned nursing institution, the indemnification paid for the nursing care provided in the state-owned institution must be based on the actual costs incurred. This indemnity item is consequently now governed by the development of real costs ­ and exposed to a higher risk of inflation. Medical malpractice insurance presents both major opportunities and significant risks. Anyone looking to be successful in this difficult market needs to acknowledge that patients' service demands are growing strongly and losses are less likely to be accepted as a stroke of fate. For insurers to achieve a positive underwriting result in such conditions, they need to have a fundamental understanding of the prevailing situation in each market and the relevant legal framework in place.

OUR EXPERT: Michael Janisch works in Corporate Underwriting and is Head of the MedMal Expert Network at Munich Re. [email protected]


MUNICH RE Topics Magazine 2/2011


Patient safety

Professor Dr. Christian K. Lackner, CEO of the Institute for Emergency Medicine and Head of the Human Simulation Center at Munich University Hospital, talks about the "human factor" in acute medicine.

Topics: Professor Lackner, the Human Simulation Center has been in existence for ten years now. What were the reasons for setting up this facility? Prof. Christian K. Lackner: As emergency medicine is an essential element of many medical disciplines, it was not regarded as a separate entity until the late 1990s in Europe. Previously, it had always been treated as a part of other disciplines. When it was finally realised that an interdisciplinary approach could make research so much more dynamic, new horizons opened up. The name of your institute also includes the term "management in medicine". What is that? Management in medicine deals with the situations that doctors encounter in their daily work. We look at classic interface aspects, particularly from the patients' perspective. Most staff found this a little unusual at first, as our analysis is firmly focused on patient safety. We soon established that patients at risk frequently have to go through any number of interfaces at the hospital. For example, once they leave the safety of the intensive care unit, a chain of errors can develop. You talk of errors. This is not a phrase people like to hear. When we started to look at the subject of patient safety about ten years ago, we were heavily criticised at first. At the time, this was still very much a taboo subject in the medical world. In 2001, at about the same time as the institute was founded, the book "To err is human" was published, which was the first book to deal with the problem of medical errors. We now know that medical

The patient simulators are state of the art.

errors are the eighth most frequent cause of death, accounting for more than three times as many deaths as road accidents. That is why it is so important to analyse it scientifically and practically in order to learn from the sequence of errors, especially if you consider that only 30% of incidents are due to technical aspects, whereas 70% are due to human factors. So, the human factor plays a major role? Yes, for too long we focused solely on technical skills, because it was assumed this is where we would find the source of the errors. People did not realise back then that communication failures and information deficits or simply a lack of teamwork can frequently cause a chain of errors. "First fly the aircraft" is one of

MUNICH RE Topics Magazine 2/2011



The Human Simulation Center: Training is most effective when people practise with colleagues they work with every day.

the key rules for pilots. If you transfer this to medicine, you have something like "Always think of the patient first". There are many acute clinical situations which require ad-hoc teams to be put together at a moment's notice. The pressure to act fast and make quick decisions is enormous. To be able to do this, you need a number of central mechanisms, which one can and must train intensively. Otherwise, the team will not be effective enough in those crucial minutes. It took us a long time to realise this. At universities people concentrated mainly on new findings and teaching knowledge. Surgery techniques were practised intensely, but never in acute or realistic stress situations. One has to train especially hard for the situations that are especially risky and do not occur very often. So, communication is a key element of training then? Communication is a key point, yes. Of course, we all believe we can already communicate perfectly. However, in a professional environment, especially those with steep hierarchies, there is frequently a lack of feedback. This may mean that the people who have to make crucial decisions in an acute situation do not have the information they need. Also, information is frequently misinterpreted. Using abbreviations is especially risky because they can mean something different in each medical field. People may find themselves talking at cross purposes. As hospital teams are essentially the same as cockpit crews or any other team working in risk environments, we really find out how people tick.

What exactly do you mean by that? Just because a group of people come together in a professional ad-hoc situation and are highly skilled in their specialist areas does not automatically make them a well-drilled and successful team. It takes a lot more than that to make a real team, such as a willingness to rely on the other team members and a common understanding of the team's objectives. That is by no means always the case. It is also important that the team speaks a common language and that there is an active exchange of information. Everyone is under extreme pressure administering treatment in the trauma room, treating or resuscitating victims at the scene of an accident or when complications arise. So what happens at these training sessions? The teams come to us from medical facilities. Doctors, nurses and paramedics often practise different scenarios together. We can accommodate up to twenty people in our four training rooms. If a group is very large, then some are given the job of observers for some drills. They sit with the trainers in the control room and watch events unfold from the sidelines, so to speak. Then they swap roles. No one is allowed to just come along and watch. If they want to bring about genuine change, then it is vital that the whole team actively takes part in the training. Many come back for refresher courses once they have completed the first stint of training, which lasts several days. What are the training scenarios based on in order to ensure they are as realistic as possible? Originally, we developed the scenarios on the basis of past liability cases. Since 2007, more or less as a consequence of the general cultural change in medicine, we have had Critical Incident Reporting Systems, which use critical events and near-misses on an anonymous basis. This is what the scenarios are based on.


MUNICH RE Topics Magazine 2/2011


Each has a storyboard and a starting point. In addition, the simulator sometimes reacts spontaneously to what is happening, for example during the administration of medicine, or the trainers may suddenly introduce new elements to the drill. What exactly is a simulator? Patient simulators are remote-controlled, lifelike, hightech dummies with all vital functions. They can talk, scream, bleed or cough as required. And they are available in every size, from new-born babies to adults. How is the scenario then analysed? We have 40 cameras and microphones that record everything from a variety of angles. After each scenario, which lasts about 15 minutes, we go to the analysis rooms for debriefing. This provides sufficient distance from the training situation just completed. This is necessary, as the training situations are not games but often push people to their limits. They can place a very high psychological strain on participants if a situation has not been handled correctly and they then have to analyse what happened. To deal with this, we have special human factor trainers, physicians with additional training in psychology. After all, experts learn best from experts. The team of trainers is monitored by a behavioural psychologist. Do you point out mistakes or do you let the participants find them for themselves? We don't do a classroom-style analysis. We watch the video and let the participants comment on what has happened. It is only very rarely that people cannot see or understand what they have done wrong. Many people training for the first time tend to focus too much on the medical side of things, for example what medicine or what dosage. When you then point out to them during the analysis that they are not communicating enough or in the right way, that they are not obtaining or even seeking the information they need to make decisions, it produces a new awareness of the situation.

You mean that raising awareness is a part of training? It is important to understand "situational attention", as some psychologists call it. In other words, if you have to make quick decisions, you tend to neglect communication. Concentrating on one task inevitably means that other things fall by the wayside. It can even mean that acoustic signals are shut out. What can help to remedy this is a short time-out together before getting on with the job. You take 15 to 30 seconds to check out the situation and bring everyone up to speed on what is happening. Can the success of the training be measured? For example, in terms of fewer incidents? Providing proof of success isn't always easy because we are talking about such rare occurrences, for example one in a thousand or so, and it is therefore difficult to put an exact figure on the success rate. No situation is identical, either. But serious complications are just the tip of the iceberg. If you want to avoid serious incidents, you have to deal intensively with what lies beneath. Shouldn't this sort of training be standard at hospitals? Some hospitals already publish their error rates in their quality reports. In many cases, such training has already become a part of risk prevention. And I would venture the prediction that in ten years' time every hospital will be taking part in such training. Otherwise, they won't get any patients.

Institute for Emergency Medicine and Management in Medicine (INM)

The institute at the University of Munich, established in 2001/2002, was developed from the emergency medicine and rescue services working group, established in 1993. It was the first facility at a German university to make teaching and research into emergency medicine its core area of study. In 2006, the 300-square-metre Human Simulation Center was added ­ one of the most modern simulation facilities for emergency medicine and rescue services in Europe. >> Further information can be found at: www.

Professor Dr. med. Christian K. Lackner has been Head of the Institute for Emergency Medicine and Management in Medicine at Munich University Hospital and its Human Simulation Center (HSC) since 2001. Prior to this, he trained in hospital management and worked for 12 years in the field of surgery, trauma surgery and air rescue.

MUNICH RE Topics Magazine 2/2011


© 2011 Münchener Rückversicherungs-Gesellschaft Königinstrasse 107 80802 München Germany Tel.: +49 89 3891-0 Fax: +49 89 399056 Responsible for content Group Communications Editor Beate Brix Group Communications (Address as above) Tel.: +49 89 3891-3836 Fax: +49 89 3891-73836 [email protected] Picture credits Title: picture-alliance/ZB p. 1: Robert Brembeck pp. 2, 11: Nord Stream p. 3 left: SambaPhoto/Andre Arruda p. 3 right: Simon Jarratt/Corbis p. 4: Munich Re p. 5: picture alliance/dpa pp. 6, 10: Nord Stream pp. 12, 19, 26, 30, 35, 44: Foto Meinen, München p. 13: Kevin Sprouls p. 14: Jane Sweeney/The Image Bank p. 18: Acervo Consórcio Construtor Santo Antônio ­ Beethoven Delano/BPSI p. 20: Getty Images/fStop p. 21: Getty Images p. 22: Gerhard Blank p. 24: Getty Images/Jorg Greuel p. 27: Karel Van Hulle p. 31: NASA p. 32: Getty Images/PhotoAlto p. 37: Gerhard Blank p. 38: Corbis/Tim Pannell pp. 45­47: Human Simulation Center, Institut für Notfallmedizin und Medizinmanagement, Klinik der Universität München Editorial deadline 3 August 2011 Printed by Druckerei Fritz Kriechbaumer Wettersteinstrasse 12 82024 Taufkirchen/München Germany


MUNICH RE Topics Magazine 2/2011

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TOPICS Magazine Issue 2/2011

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TOPICS Magazine Issue 2/2011