15 June 2006, An interview with Dr. Torsten Jeworrek
Opinion: We need to reassess the risk
In an interview with Topics, Dr. Torsten Jeworrek argues that the more frequent extreme weather events throughout the world need to be given greater consideration in risk models. He also believes that an important lesson to be learned from Hurricane Katrina is to consider the inconceivable in risk evaluations.
Tropical cyclones caused enormous damage in 2004 and 2005 – US$ 80bn worth in the USA alone. Were these exceptional events or portents of a new trend?
Dr. Torsten Jeworrek: On the one hand, the record losses of recent years can be attributed to the fact that insured losses have increased enormously. However, the hurricane losses also reflect the general trend that weather events have been increasing in frequency and intensity for several years now. Today we are seeing areas affected that we previously considered to be devoid of exposure. For example, in the past two years tropical cyclones have caused losses on the Canary Islands and in Brazil.
Is climate change responsible for these developments?
Jeworrek: We have to distinguish between two important factors. Firstly, weather extremes are increasing throughout the world, which as far as we are concerned has been clearly shown to be a consequence of climate change and partially man-made. The second aspect concerns the North Atlantic. Surface temperatures in the North Atlantic are subject to natural fluctuation over a period of several decades. As we have been in a warm phase of the Atlantic multidecadal oscillation since the mid-1990s, we have a coming together of two factors which contribute to hurricane activity.
What consequences do these weather extremes have for the insurance industry?
Jeworrek: They bring increased loss potentials and loss frequencies. This results in increased demand for reinsurance capacity and a need for higher prices in many regions. Risk management is especially important in this connection. The bar is being raised continuously – state-of-the-art is the top priority. Starting with excellent risk assessment in underwriting through to risk management at Group level, we have to be extremely disciplined in consistently implementing our scientific and technical expertise.
What specifically can our clients expect: Higher NatCat prices? Event limits?
Jeworrek: Regions and hazards that are expected to produce changes in the risk will have to undergo price adjustments – based on the resulting higher technical demands and costs of the risk capital required. However, this will not mean an across-the-board increase for global catastrophe business. We will modify our models to ensure they are appropriate to a region's and a client's prospective exposure. Event limits to restrict a reinsurer's liability in proportional business are an essential part of modern risk management.
Do you expect less pronounced fluctuations in future price cycles?
Jeworrek: Yes, we do. Firstly, there is now a much greater awareness of the role of loss estimates and exposure. Furthermore, rating agencies and regulators are calling for improvements in processes for modelling, capital requirements and risk management, both for insurers and reinsurers. This pressure is bound to produce more disciplined treatment of the risk and flatter price cycles.
We readjusted our loss models for the renewal at 1 January 2006.
Is a general reassessment of the risk necessary?
Jeworrek: There is no doubt that hurricane exposure has increased significantly. We must therefore continue the process of factoring this increased exposure into risk management and risk models. Many models are based on retrospective analyses. However, recent climate research indicates that exposure can no longer be presented in terms of a long-term average but must be calculated on a prospective basis. Even if the necessary improvements are made, modelling capabilities will still be subject to uncertainties, and companies will have to make allowance for these uncertainties by taking a conservative view in their risk management.
A question on risk management: Was Munich Re overly optimistic in its risk assessments in the past two years?
Jeworrek: Our internal risk evaluations, especially for windstorm covers, have always been conservative. Hurricanes hit the North Atlantic in 2004 and 2005 with a frequency and intensity that we had not fully anticipated in our risk-measurement calculations. We therefore readjusted our loss models for the renewal at 1 January 2006. Also, our 30 geoscientists and meteorologists continue to work together with the world of science to develop our models further.
Although simulations had clearly demonstrated the consequences of a hurricane in New Orleans, nobody expected a catastrophe on this scale. What are the lessons from Katrina?
Jeworrek: We underestimated the flood risk in our model. However, large commercial risks and industrial risks in the USA nearly all have flood cover. This is what makes the modelling of flood risks so important. Katrina, and the flooding of large parts of New Orleans that it produced, involved loss elements that we had not seen with the major hurricanes of recent years, not even in the case of Hurricane Andrew in 1992. We may have placed too much faith in the technological flood control in New Orleans, which proved to be over-optimistic on our part. An important lesson from Katrina therefore is to include the so-called inconceivable in risk evaluations.
Munich Re has placed catastrophe bonds totalling €110m for windstorms in western Europe. Are such forms of alternative risk transfer suitable instruments to diversify risks and reduce peak risks?
Jeworrek: For Munich Re, ART products such as cat bonds complement traditional retrocession instruments by passing risks on to the capital markets. Munich Re is very active in the use of these instruments, for example through the issue of PRIME capital bonds in 2000 to cover earthquake in California, hurricanes in the USA and windstorms in Europe, or the AIOLOS cat bonds for winter storms in Europe placed in the 4th quarter of 2005.
We work hard to retain our opinion leadership, our constant objective being to ensure that our clients profit from our knowledge.
Do ARTs have major potential as a new business field and are they likely to become more widely used as an investment instrument?
Jeworrek: The market is developing slowly but surely. For reinsurers, alternative risk transfers increase price transparency and reduce capital intensity, and as such can be a component of risk and capital management. In practice, the limited number of cat bond investors has tended to handicap some transactions in the past. However, the situation has since improved significantly. A few years ago when Munich Re issued its first cat bond, there were little more than 100 investors willing to invest in an insurance risk. There are a lot more investors on the market today. On the other hand, placing the cover has become increasingly complex, mainly because there are no standardised products.
What are the advantages of placing underwriting risks on the capital markets?
Jeworrek: It helps us as a large reinsurer to diversify our risk. It also enables the market to help ease capacity shortfalls in areas with peak exposures. And thirdly, if standardised instruments bring about permanent price transparency, daily trading will help to improve price discipline.
Are pool solutions to cover natural hazards on the agenda?
Jeworrek: Pool solutions already exist in some countries. Switzerland, for example, already has its Elementarschadenpool (natural perils pool). Norway, France and Spain have similar pool solutions. Japan has set up an earthquake pool for residential buildings, which shares liability between the insurance sector and the state. The USA has established the Federal Flood Insurance Program, which provides flood insurance in particularly exposed areas. Generally speaking, however, pool solutions should only be established as a last resort for the cover of peak risks – ultimately it is always the state that bears the liability. We believe that the private insurance industry should be the first port of call, as its know-how clearly makes it the superior risk carrier.
Will Munich Re continue to merit its present status as opinion leader in the field of natural catastrophes?
Jeworrek: Our expertise in geo risks makes us the global leader in the reinsurance industry. Scientific knowledge and a global network of scientists are what make us special. We work hard to retain our opinion leadership, our constant objective being to ensure that our clients profit from our knowledge. Opinion leadership is not an end in itself. We translate our findings into appropriate insurance solutions and excellent risk management.
Munich Re has set up the Munich Climate Insurance Initiative. What is the purpose of this association?
Jeworrek: The initiative's objective is to find global insurance solutions to the developments that cause climate change. It will develop products ranging from microinsurance to climate property cover. MCII shows that we are looking beyond traditional reinsurance business to find new and innovative solutions in an ever-changing risk environment. It is the only one of its kind in the world and brings together key global players from the insurance industry, UN organisations, NGOs and science, all with excellent credentials for the job in hand.
Climate change has certainly raised the profile of renewable energies. Are there sufficient insurance solutions for this segment?
Jeworrek: We give our full and active support to technologies that use renewable energies. This includes the cover of wind power plants, which we have provided for quite some time now, and support for exploration projects in the field of geothermal power. A prime example of this is the cover of a geothermal drilling project in Unterhaching near Munich, for which Munich Re was the sole reinsurer. Technological progress is always relevant to insurance, whether we are talking about credit insurance for projects or fire and engineering coverage solutions for new types of power plant. We are extremely active in this area.