Case 2-1: Munich Re-Terrorism-Related Risk Management and Ecological Issues

Case 2-1: Munich Re-Terrorism-Related Risk Management and Ecological Issues

Case 2-1: Munich Re-Terrorism-Related Risk Management and Ecological Issues

WRITE THIS ESSAY FOR ME

Tell us about your assignment and we will find the best writer for your paper.

Get Help Now!

Munich Re is the largest reinsurance company in the world. It has had its ups and downs, handling costly, massive catastrophes, but all the while, taking in profits for its innovative insurance products and maintaining its AAA rating. As a reinsurance firm, Munich Re relies on insurance firms to minimize losses. It allows for costs attributed to insurance losses to be distributed among multiple companies; as such, the reinsurance industry makes it possible for insurance companies to take risks they otherwise would not take,62 creating new opportunities for increased revenue and market share. The amount of risk assumed by reinsurers varies with the market. When the market is optimistic, reinsurers are more likely to assume greater risks; more capital is available, so the companies are capable of underwriting additional risk.63
Munich Re has been consistently rethinking its product mix and has actively pursued sustained insurance-product-related innovation in many facets of its activity. This case focuses primarily on two aspects of innovative risk management at Munich Re: terrorism risk management and ecological risk management.
Company Background
Munich Re was founded in 1880 by Carl Thieme, who, with a vision far ahead of his time, created the reinsurance business: He convinced investors of the insurance companies’ need for reinsurance as a means for redistributing risk (and loss) among insurance firms, thus allowing them to take advantage of opportunities that otherwise they could not afford to consider.64 Munich Re is headquartered in downtown Munich, Germany, where it covers a couple of square blocks with impressive older and contemporary architecture. In front of its newest building, the tall figure of the Walking Man, by American artist Jonathan Borofsky, appears to leave the complex in a hurry (see Figure 2-5).
FIGURE 2-5

The Munich Re Headquarters in Munich, Germany.
Inside the Munich Re complex, a Japanese garden offers an environment of meditation. Underground, all the buildings are connected with active corridors where color and light set a theatrical stage; here, a second “downtown”—the downtown of Munich Re employees—exists in parallel to the bustling street, Leopoldstrasse. The environment projects a strong spirit of innovation, the very theme of Munich Re’s corporate culture.65 In addition to its quest for product innovation, Munich Re was the first German company to introduce English working hours in the nineteenth century, requiring shorter days from its employees and granting them greater leisure time; the company is also among a few in Germany that provide benefits such as access to a holiday home in the Alps and an on-site daycare—the Munich Re Giants Childcare Center.66
The Munich Re Product
With a dependable brand, international presence, diversified product offering, and 42 offices around the world, Munich Re has attracted customers and investors alike, and today it remains the largest reinsurance company in the world. In the 2006 Best Review rankings, it recorded consolidated gross premiums of $26,482 million, followed by Swiss Re, with gross premiums of $23,151, and the Berkshire Hathaway Group, at $12,486.67
The company offers several different types of insurance services, such as Alternative Risk-Financing and Risk-Transfer Solutions (ART), Agricultural Insurance, Managed Care Services, and Life Insurance. ART, including Finite Risk Reinsurance and Integrated Risk Management, supplements conventional reinsurance as a means of maximizing risk retention and discovering additional financial resources. This is an area that Munich Re has pioneered and that is especially in great demand today, after the September 11, 2001, terrorist attacks. Finite Risk Reinsurance allows the company to undertake more risk by using innovative financing techniques, rather than simply by transferring risk from the insured to the insurer.
Integrated Risk Management merges insurance risks with the risks involved in financial markets—for example, in currency and interest rate fluctuation. The objective of Integrated Risk Management is to achieve both the reinsurer’s goals of the lowest possible risk and the client’s goals of highest possible security and support. Munich Re provides a number of other insurance services, covering all aspects of the economy. For example, Agricultural Insurance is a service that Munich Re has developed to protect commercial farmers in times of catastrophe and natural disaster. Its Managed Care Services, part of the Munich Re Health Division, are involved in evaluating each potential medical procedure that it insures to determine if, in fact, the procedure is essential. Finally, the company’s Life Insurance services give the company access to final consumers—a different market than its traditional business-to-business market segments (its organizational consumers).
Insurance Losses at Munich Re
Munich Re, much like other reinsurance companies, has had numerous challenges, many dealing with medical advances and genetics decoding, and others with natural disasters. For example, Munich Re had to absorb the costs involved in the recall of Lipobay, a cholesterol-reducing drug that was linked to death among users; a large typhoon in Taiwan; and a chemical plant explosion in France.68
These losses were dwarfed by the September 11, 2001, terrorist attacks. Total damages for the reinsurance industry were more than $3 billion for the disaster.69 Munich Re’s claims totaled $1.84 billion.70 Compared with competitors, Munich Re has handled the aftermath of September 11 well, and A.M. Best and Standard & Poor’s concluded that their ratings of A++ and AAA/Stable, respectively, were still appropriate for Munich Re, based on the company’s performance by the end of 2001.71 The company’s losses were offset by an increase in premium income by 20 percent; moreover, Munich Re found itself with less competition, as smaller reinsurers had incurred losses that caused them to leave the industry altogether.72 In 2002, Munich Re experienced further losses, as natural catastrophes rose sharply due to heat waves, forest fires, severe floods in Asia and Europe, as well as tornadoes in the midwestern United States.73 In 2003, more than 50,000 people were killed in natural catastrophes, such as more than 400 tornadoes in the midwestern United States, California wildfires, Hurricane Isabel, and snow and ice storms. In Europe, the company lost more than $13 billion due to the heat waves. 74 In spite of these losses, the company quickly rebounded, after deciding to underwrite more profitable businesses, with a profit of 534 million euros (US$646.4 million) in 2003.75
In December 2006, Standard & Poor’s rating was slightly lower, at AA/Stable. However, the company experienced additional losses in 2007, when high asbestos-related claims pushed Munich Re’s operations into a $1 billion loss, resulting in earnings fall of 20 percent.76
Terrorism Risk Management
On September 11, 2001, apocalyptic images from the World Trade Center and the Pentagon inundated the media around the world. The events of 9/11 marked the beginning of new levels of vulnerability for businesses, national and local governments, airlines, and individuals. The insurance and reinsurance industries experienced the largest aggregate losses ever as a result of the attacks. Half a world away, Munich Re, suffered a loss of $1.84 billion as a result of the terrorist attacks on U.S. soil. Before September 11, 2001, terrorist attacks of this magnitude were inconceivable and were not considered in the calculations of premiums and the like. According to P. J. Crowley of the Insurance Institute of America, “There has never been a premium dollar collected to cover terrorism.”77 Reinsurance firms had to reconsider their stance on what coverage they would offer in the event of future terrorist attacks. Many insurance and reinsurance companies included clauses in their policies that exclude the coverage of losses from any type of terrorism. Munich Re “was hit by the claims from September 11 more than other members of the reinsurance industry and thus it had to make careful decisions concerning what to do about providing protection against terrorist claims.”78
Reinsurance companies were not well prepared to handle a loss event of the magnitude of September 11. In 2001, the faltering state of markets worldwide depleted the reinsurance companies’ capital. As a result, the reinsurance industry, and Munich Re in particular, were forced to explore the different ways in which it could alter the mix of products offered to insurance firms all over the world and their pricing strategies to most effectively operate in the present volatile environment. In an effort to adapt to the new, post-September 11 business environment and its new challenges, the insurance and reinsurance firms were forced to change their entire marketing mix. Munich Re underwent a complete overhaul of its marketing strategy.
Changing the Marketing Mix at Munich Re
No reinsurance company had ever considered terrorist actions of such magnitude when calculating Probable Maximum Loss (PML) for the properties insured. Insurance companies had to cover losses of more than 1,200 corporations housed in the World Trade Center complex, damage to the operating areas, loss of experienced employees, and destruction of business data and business income. More than 50 buildings were affected in addition to the World Trade Center, and 150,000 people were out of work permanently or temporarily.79 These extreme circumstances led the reinsurance companies to change their marketing mix—especially the reinsurance product and its price.
According to Nicholas Roenneberg, senior executive manager, Corporate Underwriting—Global Clients division at Munich Re, if such a catastrophe were to happen, it did so at an opportune time for the company—when the company was renewing its policies for the year. At that point, the company placed all policy negotiations on hold so that it could reconfigure its marketing mix. For the short term, Munich Re determined that terrorism was no longer insurable, given the high risks especially in high property concentrations because in these environments, it was impossible to estimate the frequency of such attacks and their total impact, thus presenting a situation in which an important criterion of general risk insurability, assessibility, cannot be met. They were joined by most insurance companies, which decided to exclude terrorism risks from their commercial policies. However, the Terrorism Insurance Act, or Tria, signed into law by President George W. Bush in 2002, required insurers to offer cover for certain acts of terrorism that are “certified” by the U.S. government.80
In the long term, Munich Re decided to offer custom-insurance options for properties evaluated at more than 50 million euros (more than US$65 million), on a case-by-case basis. Ultimately, all types of insurance options were subject to negotiation. No terrorism exclusion, however, was imposed on life and personal accident insurance. In addition to insurance, Munich Re and most other insurers require some exclusions in property insurance and partner with local and state government to provide coverage.81
According to Christian Lahnstein, a specialist in genetic engineering law and liability law with Munich Re, the company studied at length the issue of government intervention and bailing out industries affected by disaster. It also studied issues related to the equity of distribution of funds from the government and charitable sources. The company used this information in decisions related to the company’s marketing mix.
One issue currently under consideration at the company is related to the costs of corporate terrorism, which is driving up the price of directors’ and officers’ liability insurance. These are traditionally known as long-tail risks—risks that are not immediately apparent to the insurers and insurance buyers. Munich Re is among the first firms in the industry to offer coverage specifically for this type of risk.

Munich Re-Terrorism-Related Risk Management

Interestingly, German companies themselves do not feel compelled to purchase terrorism coverage, despite major attacks in the European Union—London and Madrid, among others. The German government provides terrorism coverage through Extremus, a government-backed insurer created in 2002; however, the insurer has little demand for coverage, even though there is little doubt about the continued presence of terrorists in the country. The reason is that the insurance is expensive, two to three times the cost of terrorism coverage under the U.S. Terrorism Risk Insurance Act.82 However, in the United States, businesses are purchasing terrorism insurance at record levels: nearly two thirds of large businesses and 60 percent of mid-sized firms purchased the insurance. 83
Environmental Risk Management
Every risk that global warming poses to the planet—higher sea levels, more frequent and intense storms, drought, flooding, heat waves, and winds–will come up in the balance sheet of an insurer. Munich Re has conducted extensive research on the issue and has the best climate scientists working for them. They are doing information and risk modeling to determine how much insurers should be paying for reinsurance. And, to respond to these risks, Munich Re developed innovative financial products, such as weather derivatives and mortality bonds.84
European environmental liability extended initially only to personal injury and property damage. However, in 2007, it also extended to statutory liability for damage to the environment. Munich Re immediately changed its coverage to environmental risks, as its traditional insurance did not adequately cover environmental risks. In the new European perspective, for instance, environmental consequences of fires and explosions are considered damage. For environmental damage, Munich Re requires risk assessment, underwriting, and damage remediation to be performed only by experienced scientists, engineers and specialist underwriters to ensure that the company remains profitable in the environmental sector.85
The basic principle of the EU environmental liability directive is that anyone who causes damage to the environment has to pay to have it cleaned up. This polluter-pays principle ensures that society as a whole no longer has to bear the costs of public law claims, as has so often been the case in the past. For example, land must be decontaminated until it no longer poses any significant risk to human health and the damaged protected species, natural habitats, or waters, must be restored to their original state. All remedial measures must compensate for the loss—to offer an example, damage to 100 valuable old trees could be compensated for by the planting of 1,000 new ones. To start with, the EU does not yet require mandatory insurance. However, the Commission will report to the European Parliament and the European Council in 2010 about the availability of suitable insurance products. Subsequently, the Council will decide whether the directive needs to be amended to introduce mandatory insurance in all states. It should be noted that the directive does not include cases of force majeure; nuclear damage; maritime oil disasters; or cumulative damage, such as forest decline.86

Munich Re-Terrorism-Related Risk Management

Lascu, D. N. (2008). International Marketing, 3e, 3rd Edition. Cengage Learning, VitalBook file.