Opinion: Reinsurance offers great flexibility and corporate independence

Solvency II will significantly change the importance of and demand for reinsurance cover. In addition to standard products, there will be increased demand in the future for solutions more closely geared to individual risk parameters and providing a high degree of flexibility.

Under Solvency II, assessment of an insurer's capital requirements will be much more closely linked to its overall risk situation than is the case with Solvency I, which focuses primarily on the volume of premiums and claims to determine the required capital. In future, the individual risk structure of an insurance company may be determined either by means of an internal risk model or through a standard approach. Smaller companies are likely to opt for standard solutions to start with.

Implementing Solvency II may entail enormous effort but it will enable companies to identify their biggest risk drivers and to significantly optimise capital allocation. A must for every insurer preparing for Solvency II will be to implement a system of value-based management. Insurers need to be able to determine optimal returns on the capital employed in order to achieve long-term growth. Basically, the insurance industry has to prepare for three developments in particular:

• 1.
  The need for risk capital risk will tend to increase.
• 2.
  Insurers will be able to influence this demand to a certain extent by adjusting their portfolios.
• 3.
  Individual reinsurance solutions will play a more important role in covering capital requirements.

Options available to the insurance industry

One crucial aspect for individual insurers will be to strike the right balance between solvency and return. If risk capital is inadequate, management can take suitable countermeasures by reducing risks and withdrawing from certain markets or lines of business. However, such action may jeopardise future business opportunities. It would also have numerous negative effects, for example on sales organisations or the relative increase in fixed costs.

If insurers want to maintain business opportunities or if capitalisation is still too low after the portfolio has been adjusted, they must consider how they can best meet the solvency requirements. Of the three options available — reinsurance, capital increase and the transfer of risks to the capital markets — reinsurance offers the greatest level of flexibility and corporate independence. It can be deployed flexibly in terms of time and aligned to individual requirements, and permits solutions that "breathe" with the portfolio, whereas the alternative instruments still tend to be too rigid at present. A company's size and legal form will determine whether access to the capital markets is possible. Moreover, capital measures still tend to generate relatively high transaction costs, and measures which tie capital down for a period of several years make it very difficult to react flexibly to fluctuations and changes in the portfolio.

Implementing Solvency II may entail enormous effort but it will enable companies to identify their biggest risk drivers and to significantly optimise capital allocation.

Over the last few years, Munich Re has been able to build up an extensive compendium of knowledge on the Solvency II Project. It already has a wealth of experience in the development and use of internal stochastic risk models and their linking to value-based portfolio management. Integrated risk management with its far-reaching aspects is a fundamental pillar of our business model. Furthermore, our experts are actively involved in important national, European and international supervisory and technical bodies and ensure that knowledge and recommendations for action are translated into our operative business. Munich Re is thus ideally positioned to partner its clients through-out the entire Solvency II process. This is also true of accounting issues. If the solvency requirements were not synchronised with the consequences of accounting on the basis of IFRS, a distorted picture would emerge that could conflict with the original intention of the Solvency II initiative.

Determining the structure of insurers' reinsurance programmes plays an important part in optimising their solvency capital requirements. For such cases, we have sophisticated and established modelling instruments to develop individual reinsurance programmes tailored to individual risk structures and solvency objectives. The results of this modelling provide insurers with the knowledge needed to set up a systematic strategy and to plan appropriate measures.

The more specifically structured the Solvency II rules become, the more new products, tools and services will be developed. Integrated offers could encompass all three components in some risk categories. Protection models also need to be considered for additional risk categories which have thus far not been a focal point of attention, such as credit risks or operational risks.

The trend towards individualised products will also affect business practices between insurers and reinsurers. Selective information will no longer be sufficient to properly assess the overall risk situation and find tailor-made solutions. The more transparent the portfolio structure and risks (such as interest rate, currency and market risks), the more needs-specific the reinsurance can be and the more risk-adequate the premium. Accurate and precise information is thus also very much in the interests of the insurer.

One thing is already abundantly clear: a reinsurer's product and service competence related to Solvency II will become ever-more significant from the cedants' point of view and cooperation will become closer and more intensive. Thanks to our excellent knowledge of Solvency II, we are ideally placed to accompany our clients as preferred partners along the path to the new solvency rules.

Dr. Thomas Blunck is a member of the Munich Re Board of Management responsible for the Special and Financial Risks Division and IT.