Tony van Niekerk spoke to Dr Arnoldussen, Member of the main board of Munich Reinsurance, Germany, about the impact of the global crisis on Munich Re, their strategy going forward and the outlook for the next year.
Naturally Munich, as a major institutional investor, has also been impacted. However, we were much less impacted than our competitors as we were not too exposed to toxic assets. We already lowered our equity exposure in 2008, after having reduced our big equity participation since the post 9/11 equity crash. We invested a lot in our internal risk management systems and entered the crisis with a good overview of our risk exposure. We acted responsibly by continuing to reduce our equity exposure with the result that our un-hedged equity exposure is currently under 1%. There is also very little credit risk exposure to our profits which means we can pay a dividend of about € 1 bn. These are clear signals that we can continue with our business strategy, despite the crisis. Understandably, our share price also went down but we are still outperforming our peers. We have great trust in our asset allocation and strong balance sheet because analysts look carefully at the balance sheet and assets in these times.
We have a credit default spread of 60 to 80 b points. Debt will therefore be well-priced compared to our peers. Many insurers don’t rely solely on ratings but also look at CDS and other indicators when making decisions.
Operational measures – We expect a long recession of two years or more and also consider worse scenarios and therefore stress test the company for these, while keeping close track of information and changes in market. Directors and Officers exposure has definitely increased across the market, especially in banks and elsewhere in industry and commerce. However, pricing is not reflecting this and we therefore want to decrease our exposure to this. The same goes for credit insurance exposure, where we have seen significant increases in defaults across the globe.
We also carry a very low risk portfolio with almost no equity exposure to ensure preservation of our capital. We are convinced the hardening will continue and we must ensure we benefit from it. The downside is that investment returns are lower and we must increase prices to maintain income as insurance is long tail business and necessitates that.
It is unavoidable and necessary that the US government stepped in. We are not a creditor so not exposed to credit risk, but AIG did big business in capital markets and that impacts others. If they had failed after Lehman, it could have resulted in a global meltdown. It is only in the second wave fallout, as institutional investors, that we are affected. The bail out, in general, should be evaluated carefully. If there is systemic risk, intervention is needed. In AIG’s case, there were strong reasons for the Federal Reserve to act.
Immediate future – Premium growth will definitely slow down as clients’ business decreases. Growth prospects have therefore been adjusted down. Recession is not always good or bad. History has shown that we can make profit in so-called “bad years”. Risk is sometimes reduced due to decreased business operations while premiums have already been paid on higher volumes of production. Machines are used less which initially reduces risk but then maintenance may also be reduced, which again increases risk. Usually we also see more fraud and arson. However, with tighter claims management and appropriate pricing, we can reduce our risk.
If the recession continues, Directors and Officers Liability claims will increase and equity capital of insurance share of risk comes down. This is also true for reinsurers, however. Reinsurance is the only a real substitute for capital and reinsurers should benefit from the reduced capital in the market and, with our strong balance sheet, we hope to benefit.
Immediate future – We believe that worldwide growth in the insurance industry will come from the developing world. There will be reduced growth but it will still be positive. As far as South Africa is concerned, we are expecting lower but positive GDP, many privately funded projects will be cancelled or postponed and governmental investment should generate growth while stabilizing the market. The African market, in general, will probably show good growth. In this regard, for example, Sudan and Nigeria are showing potential.
Internally, claims management will remain a focus area for Munich as the importance of this function has been brought to the fore by the economic climate. Items like Business Interruption Cover, for example, need close inspection and monitoring. As part of this, we bring together a good mix of insurance professionals, accountants, lawyers and actuaries to work jointly and learn from each other. We have not seen the end of hardening in the market.
We have been quite active in further improving our pricing models but realize that no model should substitute the knowledge of the underwriter. We aim to increase skills levels in the underwriting units and make further use of scientific underwriting models. We are also improving catastrophe models with people like Prof Stern, and sponsor projects to increase the knowledge and implementation of these models and to develop earthquake models, which are becoming very complex. The industry must bring together the minds from around the world for all to benefit from this development in modeling.