"Guest column: Internationalisation – risk or" magyarul

Guest column: Internationalisation – risk or opportunity?
Torsten Jeworrek NOVEMBER 18, 2008

The internationalisation of the economy is not as recent as the buzzword “globalisation” would have us believe. In fact, it was internationalisation that paved the way for the beginnings of the insurance industry back in the 14th century, as shipowners sought to protect the increasing value of their ships and cargoes. A document from 1347 is believed to be the oldest marine insurance contract.

Even today, the complex nature of risks emanating from international trade is one of the insurance industry’s most difficult challenges and one that affects all classes of business, as the following examples show:

1. More than 90 per cent of all world trade is transported by sea or other waterways. The largest container ships today, with cargoes of up to 13,000 containers, may be worth far in excess of $1bn. However, even this concentration of values is small compared with that found at the world’s great container ports, such as Singapore or Hamburg, which act as depots to goods worth tens of billions of dollars every day.

2. The outsourcing of production sites to low-wage countries does not just reduce costs. It can also reduce the quality of the goods produced. Defective products can result in recall costs or even product liability costs. Recent examples of recalls that spring to mind include toys coated with lead paint and toothpaste contaminated with the antifreeze diethylene glycol.

3. Liability losses can reach extreme proportions when pharmaceutical products cause dangerous side-effects in patients. National law in the country where the products are sold plays a key role in this connection. The US, in particular, has seen some extremely high awards for damages. For example, in November 2007 pharmaceutical giant Merck had to pay $4.85bn damages in the US alone following several thousand cases of heart attacks and strokes caused by its Vioxx painkiller.

These examples highlight the enormous extent of the insurance industry’s role in the global economy.

Insurance companies that cover such large risks need a secondary market where they can place them. Reinsurers assume this function. Sharing the load among several carriers helps to spread the risks. The diversification effects achieved by spreading risks across different regions and classes of business allows reinsurers to balance their portfolios and realise a level of capital efficiency that enables them to cover their clients’ risks – and ultimately those of the insureds – at a reasonable price.

Extreme losses in the past show just how important the reinsurer’s role is. One of the biggest loss events in the history of insurance was on September 11, 2001. The attack on the World Trade Center in New York was a prime example of the complexity of today’s risks, with accumulation of losses across a range of insurance classes such as fire, business interruption, liability, life and health, and compounded by significant capital market losses. The economic losses could only be remotely estimated at $100bn. The losses for the international insurance industry came to $40bn, with $24bn of this covered by the reinsurance industry.*

The insurance industry also bore the brunt of the losses in the 2005 hurricane season with Rita, Wilma and Katrina. Some US$ 94bn of the aggregate losses of US$ 180bn was borne by the insurance industry, US$ 42bn by the reinsurance industry alone. *

The insurance of large and accumulation risks is a definite advantage for the sustainable development of economies. In countries where insurance is not very far advanced, it is the vulnerable economies and above all the inhabitants that have to bear the brunt of these losses. The tsunami of 2004 not only brought immense human suffering but also caused losses of over US$ 10bn. As the insurance density in the regions affected is still very low, the insurance industry only covered a small percentage of these losses, less than US$ 1bn.*

Countries with an underdeveloped system of insurance suffer immeasurably more from major catastrophes than those where a good part of the material losses can be covered by professional risk carriers.

Reinsurance has always been an international business since its beginnings in the middle of the 19th century. By assuming a number of independent risks in different regions of the world, reinsurers create a balance in their portfolios. However, the causal and regional links between risks used to be much less pronounced than they are today. The global economy is increasingly networked and interconnected. Risks are becoming ever more complex and the insurance industry has to develop new concepts for its clients in order to meet their need for risk cover in this changed environment.

To respond to this development, enterprise risk management has become increasingly important, especially for reinsurers themselves. They have to consider not only the complexity of the original risk, but also the fact that one and the same risk frequently comes from a large number of different sources, such as through international insurers.

To deal with these challenges, Munich Re has founded a central unit, Integrated Risk Management, which is responsible for uniform group-wide identification and handling of large and accumulation risks.

The regional business units, supported by a global network of local units, are thoroughly familiar with the special features of the individual markets. Together with clients, they develop solutions for the assumption of risks. Centralised risk management processes ensure that cross-regional and cross-line risks are identified and suitably limited in Munich Re’s aggregate portfolio.

In this process, there is clearly a lot more to consider than just the underwriting risk. For example, if we cover significant product-liability risks of a pharmaceutical company, we do not then buy large amounts of stock in this company. This ensures that we are not struck twice when large claims payments are accompanied by a fall in the company’s share price.

Failure to implement such a holistic risk management policy can lead to a dramatic underestimation of the true risk position.

This has been evident in the current financial market crisis. For successful risk management, it is essential to identify concentration risks and systemic risks for which diversification in the portfolio does not work.

Far-reaching risk trading mechanisms can lead to very high systemic risks for the entire sector involved. The insurance industry has therefore created global standards. It learnt its lessons from the LMX (London Market Excess of Loss) spiral in the late 1980s, where risks were passed on endlessly in the London market. Two key principles in the global insurance systems are that players must have a sizeable retention in the insurance risk, and that risk transfer in the insurance sector ends with retrocession, or the protection of reinsurers. There may be no further transfer of risk beyond this.

Munich Re seeks to achieve a suitable balance between opportunity and risk – to play a meaningful role in global economic development and in so doing create profit for our stakeholders.

At the same time, we also want to contribute to economic and technological progress and thus to the development of society as a whole. We do this by providing our clients with as much capacity as possible and with optimal innovative solutions – for example through the cover of new climate-protection technologies.

With our Integrated Risk Management we ensure that our company is protected against losses that may threaten its existence – so that we are always in a position to meet our obligations to our clients.

*All the loss estimates above are in 2007 dollars (adjusted for inflation).