2 August 2007

Interview with Dr. Jörg Schneider: Part 1

Solvency II – Implications for the insurance industry/Relationship between primary insurers and reinsurers

In the first part of our interview, we ask: What does CFO Jörg Schneider expect of Solvency II? And what can Munich Re's clients expect?

Munich Re Info: Dr. Schneider, what is the significance of Solvency II for the insurance industry in your view?

Dr. Jörg Schneider: Solvency II will revolutionise the business parameters of the insurance industry. The development towards a more risk-based approach is a fundamental change and will have a positive effect on both the product range and the financial parameters.

Munich Re Info: You take an optimistic view of Solvency II, then?

Schneider: Yes. I am very impressed by what the European Commission and CEIOPS have achieved in a short time, especially given the difficult material. The recently submitted directive proposal in particular is an important milestone. There may be criticism of certain details – concerning the diversification effects of the different types of risk, for example – but what has now been submitted is of remarkable quality. The insurance industry overwhelmingly supports the principles of Solvency II – the politicians must now ensure that it is strictly implemented.

Munich Re Info: Solvency II will force primary insurers to manage their business more exactly. Reinsurance will therefore tend to be purchased with greater precision in future. Won't that reduce reinsurers to pure capacity providers?

Schneider: Clients can approach it that way – those that just want capacity from reinsurers in future will continue to get it. But they will ultimately be losing out by doing so, because they won't be taking advantage of the option to collaborate with the reinsurer in designing their ideal coverage programme.

In a word, compared with today we will have more clients that determine their reinsurance requirements very precisely based on an analysis of their risk position. Our challenge will be to satisfy these clients and their needs with our expert knowledge.

Munich Re Info: Isn't that thinking too positively? A client that determines its reinsurance requirements with its own internal model knows very well exactly when it is more favourable for him to substitute reinsurance for equity capital.

Schneider: That may be the case with the large, globally operating insurers. Nevertheless, the client relationship with them can be more broadly structured and take on project-oriented features – because we can add value with tailor-made solutions based on a holistic view of the risks.

But most insurers will find themselves having to use the standard models at the beginning. For them in particular, reinsurance is the most flexible and efficient form of capital substitution. In this case, we have to sit down with the client and analyse its risks, precisely identify their impact in the applicable standard models, and from this determine the client's individual relief requirements.

Munich Re Info: That sounds as if consultancy skills will be needed.

Schneider: Yes, exactly! We need to be completely au fait with the rules of capital management. Besides pure risk evaluation – the core part of our service – our consulting will have to provide a comprehensive view that takes in value-based management and the effects on accounting. With such elements of holistic financial consulting, we are getting close to the service approach used by investment banks.

Munich Re Info: What will Munich Re do for its clients before the launch of Solvency II?

Schneider: No insurer can sit back and simply wait for the legislation implementing Solvency II to enter into force. Only reinsurers who accompany their clients along the path to Solvency II can also be active partners at the start. In the coming months, insurers and reinsurers have a steep learning curve ahead of them. The switch to managing business and capital on an exposure basis is a demanding one; the models to be used are sometimes complex. In business practice, the requisite management principles will have to be introduced into the organisation in a suitably simplified form.

We will give our clients the best possible benefit of the knowledge edge we have acquired from using our own internal risk model for several years. The more precisely our clients know their risks, the better we can tailor our coverage programmes to their needs.

Munich Re Info: In other words, the initial steps should be taken now, such as the first quantitative approaches to determining capital requirements?

Schneider: Exactly, for example by participating in the quantitative impact studies like the recent QIS3, even though the requirements will change somewhat between now and the final calibration.

Munich Re Info: When would you recommend that primary insurers should start doing something?

Schneider: If they have simple structures and a non-complex business model, they will generally be able to use the standard model. Although this does not model reality sufficiently well everywhere, it is more straightforward to use than internal models. But if companies want to make a real opportunity out of the challenge, they should start looking at internal models as early as possible. Solutions that are rudimentary to begin with can be continually refined. Besides this, there is the compromise of the "partial model". With this arrangement, the most important types of risk can be modelled, whilst standard approaches are employed in less sensitive areas. In other words, those who can already envisage moving in the direction of an internal model should start taking a serious look at this option very soon. Munich Re will be glad to help them.

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Interview with Dr. Jörg Schneider: Part 2

Solvency II – Munich Re’s role/Relationship between reinsurance and the capital markets

Solvency II will also mean supervisory changes. Will capital market solutions squeeze out reinsurance? Jörg Schneider on the future of reinsurance.

Munich Re Info: The much-heralded changeover to qualitative supervision primarily relates to Pillar 2, the supervisory review process. What part will Munich Re play in this context?

Schneider: Together with our clients, we will concentrate our efforts on capital efficiency and give them risk management support. However, the supervisory approach concerns the insurance company’s overall risk position so that quantitative and qualitative aspects cannot be regarded as completely separate issues.

Our role will essentially be to give comprehensive advice about value-based management, and present reinsurance as the most flexible product available. We will not, however, be offering a service confined only to reinsurance consultancy.

Munich Re Info: Isn’t value-based management in any case an absolute must for active insurance company management?

Schneider: That is true. Active portfolio and capital management based on prospective planning data, tailored to the company’s business situation, is an indispensable part of this.

Munich Re Info: Turning now to the total balance sheet approach, are we in future to expect that reinsurers will move into product ranges whose origins lie on the assets and the liabilities side?

Schneider: Yes, definitely. This holistic view of the risks on the assets side of the balance sheet and in the actual insurance business – also bearing in mind their interdependency – is very much a part of the new supervisory rules. Our products will be based on this, and we will at the same time take investment and asset-liability risks into account.

Munich Re Info: Basel II proved a major boost to risk securitisation in the credit sector. Can we expect a similar boom in insurance-linked securities?

Schneider: Insurance risk securitisation got off to a slow start but it has grown considerably and will become increasingly important in the future. However, this trend has its limits. Insurance risks cannot be standardised to the same extent as credit risks in the banking sector. Therefore, I don’t expect the scale of securitisation in insurance to be anything like that of banking risks.

Munich Re Info: But don’t we risk losing substantial shares of our core business to the capital markets in the long term?

Schneider: That such capital market products will gain a foothold is beyond doubt. But they are not as flexible as well-structured reinsurance cover and, at least as things stand at present, the transaction costs are higher.

Nevertheless, we can expect major changes not only from Solvency II but also from the increased blurring of the borders between insurance and the capital markets. So for reinsurers in particular there are challenging times ahead. Our response to this is our Changing Gear initiative: we will focus on giving our clients an excellent, all-round consultancy service, tailored solutions and innovative products.

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Interview with Dr. Jörg Schneider: Part 3

Solvency II – IFRS/Rating & supervision

The insurance industry does not only have Solvency II to think about: new accounting regulations are just around the corner and the requirements of rating agencies and supervisory authorities are going to increase. However, this will also bring benefits, as Dr. Jörg Schneider points out in the third and final part of the interview.

Munich Re Info: Dr. Schneider, the new accounting regulations will virtually coincide with Solvency II. Is IFRS a help or is it a further notch on the complexity scale?

Schneider: I regard IFRS more as an opportunity than a risk. Again, the overall tendency is to base valuation methods on market values. At the beginning of May, the IASB published its draft on new accounting standards for insurance contracts. This uses "current exit value" to determine insurance liabilities, an approach that is at least close to the one taken by Solvency II. That could result in considerable differences in risk, service and profit margins. But whatever happens, provision will have to be made for a transition from one set of rules to the other in order to keep insurers’ costs within reasonable limits.

Munich Re Info: Solvency II and the accounting reforms place an immense burden on the industry and the response has not been completely positive.

Schneider: The concerns expressed are understandable. However, we should bear in mind that only a relatively low percentage of publicly-traded insurance companies will have to apply IFRS, these being typically the major players. Nevertheless, medium-sized companies not yet listed on the stock exchange would also do well to concern themselves with IFRS so as to be able to issue exchange-traded debt instruments later on, if necessary.

Munich Re Info: There were also hopes that it would be possible to synchronise the Pillar 3 disclosure requirements under Basel II with those of IFRS. However, in the course of the discussions it has become increasingly clear that the different disclosure requirements drift a very long way apart. Is the same fate likely to befall Solvency II and IFRS 7?

Schneider: No, because the accounting side has since come on considerably. Under IFRS 7, we are in any case obliged to disclose many of our risk exposures in the notes to the annual financial statements, thus addressing a very important Pillar 3 concern. Insurers should not be subject to still more extensive reporting requirements in addition to the already very detailed accounting. Not only does excessive reporting cost companies a lot of money; churning out still more figures would be of no benefit to policyholders.

Munich Re Info: Rating agencies and supervisory authorities both now advocate an economic view. Will this reduce the rating and supervisory workload?

Schneider: Firstly, both will tend to involve more work than in the past because their requirements will generally increase. However, despite having slightly divergent objectives, both rating agencies and supervisory bodies are moving towards a genuinely risk-based, holistic view of the business risks and corresponding security; they are moving closer together, and that is a positive development for the companies they review.

Munich Re Info: Will the work involved in servicing the different models be worth it?

Schneider: The rating agencies use some factor-based models, which are superior to the traditional Solvency I criteria. In order to ensure global comparability, they will continue to rely on their own models in future, whilst being aware that the models do not adequately reflect the economic conditions and risk situation. For rating agencies and supervisory authorities, the quality of a company’s risk management and the results of capital analysis, obtained using internal models that meet certain minimum requirements, will become increasingly important. In this way, setting up a good risk management system will directly affect a company’s capital requirements and thus its corporate value.

Investing in risk management will therefore also pay off in economic terms – not just in times of crisis but also when it’s "business as usual"!

Munich Re Info: But what about smaller insurance companies? Won’t they see their star in the descendant because they aren’t as quick to satisfy demands such as implementing internal models or deliver diversification effects that match those of the global players?

Schneider: Both are very real concerns. But the small companies can offer advantages such as lower levels of complexity. Furthermore, thanks to their close customer contacts and in some cases substantial niche market shares, many small-sized insurers have the edge over a number of the major players.

They will be able to compensate for disadvantages such as the absence of diversification by judicious use of reinsurance for risk homogenisation and smoothing of peak risks.

I therefore firmly believe that there is a future for small, adaptable insurance companies.

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