No. 19. A Berkshire Hathaway Company

Transcription

1 No. 19 A Berkshire Hathaway Company

2 Topics No. 19 Publisher General Reinsurance AG Theodor-Heuss-Ring Cologne Editors Sabine Denné (responsible) Tel Ursula Smoll Tel Art Direction Krall & Partner Werbeagentur Duisburger Str Düsseldorf Print Brandt GmbH Rathausgasse Bonn Photos dpa Picture Alliance Shutterstock istockphoto fotolia General Re Corporation, Stamford, CT, 2012 General Re General Reinsurance AG, Cologne, 2012

3 General Re Corporation Selected Consolidated Financial Data (Amounts in millions of U.S. dollars) Total investments 28,299 28,376 Investments 23,804 24,621 Cash & cash equivalents 4,495 3,755 Total assets 37,603 37,993 Underwriting reserves 20,813 20,726 Shareholders equity 12,415 12,570 Dividends 675 1,300 Return on equity 7.2 % 7.3 % Premiums written* 5,819 5,632 Life/Health 2,909 2,709 Property/Casualty 2,910 2,923 Premiums earned* 5,815 5,693 Life/Health 2,875 2,714 Property/Casualty 2,940 2,979 Underwriting result* Life/Health Property/Casualty Combined ratio* 97.5 % 92.1 % Life/Health 95.2 % 94.0 % Property/Casualty 99.8 % 90.3 % Total investment income 1, Net investment income 1,092 1,140 Realized gains/losses Net income * Amounts per Berkshire Hathaway Annual Report which excludes the impact of the intercompany loss portfolio and quota share retrocessional agreements between certain General Re Corporation and Berkshire Hathaway Inc. affiliates. Gen Re s Ratings: Standard & Poor s: AA+ A.M. Best: A++ Moody s: Aa1 Fitch: AA+ Financial strength ratings of Gen Re s reinsurance operations

4 Renewable Energy Sources Development and Perspectives 4 Kathrin Haltenhof Offshore Wind Energy in Europe Fresh Wind for Insurers, Too? 10 Oliver Stein Liability Insurance for Wind Energy Projects 16 Dmitry Danilin The European Battle Over Sex Human Beings Are Above Statistics 24 Andres Webersinke Yonder Lies the Way or How to Manage Process Risk in Insurance Sales 32 Astrid Kahl Periodic Payment Orders in the UK A Reinsurer s View 38 Mike O Dea, Ines Hellmayr and Geoff Piggot A Year After the Tohoku Earthquake 46 Takashi Ishii Summaries 52 Adresses 54 General Re Corporation Selected Consolidated Financial Data 55

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6 Renewable Energy Sources Development and Perspectives Kathrin Haltenhof Kathrin Haltenhof is an underwriter in the Treaty unit Germany Austria Switzerland. Her main area of responsibility is engineering insurance. Tel: Definition and review Renewable or regenerative energy sources are defined as those where electricity, heat or fuel is generated by wind or solar energy, bioenergy, geothermal power or hydropower. Windmills and water wheels have been generating energy for centuries. Due to the ability to transport electricity over long distances, a new era began at the end of the 19th century, when the first hydroelectric power plants for generating power were built, such as the one at Niagara Falls that went into operation in Today, hydroelectric power plants supply about 24 % of the world s electricity. Thanks to its geology, Norway generates 100 % of its power needs with hydropower. What is currently the largest hydropower plant in the world, the Three Gorges Dam, went into operation in China in Industrial power generation using wind, solar and biomass has played an important role for about 30 years. In the late 1970s, during the second oil crisis, there were discussions about renewable energy and its increased use. Fossil fuels, such as oil, natural gas and coal, have restricted supplies; furthermore, their intensive use is responsible for the increase in greenhouse gas concentrations in the atmosphere. Since the global energy demand continues to rise, ensuring a reliable, economical and environmentally friendly energy supply is one of the great challenges of the 21st century. Renewable energies already play a prominent role today. Renewable energies and climate protection One goal of climate protection is to reduce greenhouse gases. The Kyoto Protocol of 1997 identified four greenhouse gases, including carbon dioxide (CO 2), as the main causes of global warming; the concentrations in the atmosphere of two other gas groups were singled out as needing to be stabilized, thus minimizing global warming. With ongoing global industrialization especially in emerging countries the OECD estimates that worldwide CO 2 emissions will increase by about 30 % until While a slight reduction in CO 2 emissions is forecast for the OECD countries, 2 emissions will increase massively in countries such as China, Brazil and India. In China, for example, one new coal power plant goes online every week to meet 5

7 CO 2 emissions in Germany (in 1,000 tons) Figure 1 1,100,000 1,000, , , , , , , , , , Energy industry Transport sector Private households and small consumers Commerce and industry Other Source: Umweltbundesamt, Nationale Trendtabellen für die deutsche Berichterstattung atmosphärischer Emissionen seit 1990 (as of April 2011). the growing energy demand. Overall, the International Energy Agency (IEA) estimates that global energy demand will increase by at least 50 % until 2035, depending on the scenario, because more than one billion people worldwide still live without electricity. 3 Since the early 1990s, Germany has supported the expansion of renewable energies by means of laws and regulations, and has since achieved a reduction in CO 2 emissions by about 24 % in spite of increasing primary energy consumption. The importance of political frameworks An appropriate political environment is imperative for the development of renewable energies. Heat and electricity from renewable sources are still significantly more expensive than those from existing conventional power plants. Often it is only government funding that can provide sufficient incentives for energy companies or private households to build wind power, solar and biogas facilities. established objectives for the use of renewable energies; some provide financial incentives. These objectives are based on the installed capacity, depending on the technology (in megawatts, MW), on a percentage of electricity generation or on a country s final energy consumption. In the European Union (EU), 20 % of the final energy consumption is to be produced using renewable energy by The implementation of the Community s objectives is the Share of renewable energy in gross final energy consumption Figure 2 60 % 50 % 40 % 30 % 20 % 10 % 0 % -10 % In some countries, this support began in the late 1980s. Today, more than 80 countries have governmentresponsibility of the individual countries, as their goals and current levels of achievement are very different. Non-European countries have also committed themselves by setting goals; even China would like to satisfy about 15 % of the final energy demand using renewable sources by 2020, taking into account an annual increase in energy demand of approximately 15 %. 4 Renewable energy as a socioeconomic factor Another factor in the expansion of renewable energies is that the labor market has benefited in recent years from this development. For example, the number of jobs in Germany has more than doubled to 360,000 within four years and is expected to rise further. In other EU countries, a similar development is expected. Currently, about 550,000 people work in this sector in Europe. The European Wind Energy Association (EWEA) estimates that the number of jobs in Europe in the wind energy industry will rise to about 450,000 by Today, there are approximately 96,000 jobs in wind energy in Germany alone, and the trend is for even more jobs. In the solar/photovoltaics sector, over 190,000 jobs were created throughout Europe; in 2010, Germany had Austria Belgium Bulgaria Cyprus Czech Republic Denmark Estonia Finland France Germany Greece Hungary Ireland Italy Latvia Lithuania Luxembourg Malta Netherlands Poland Portugal Slovak Republic Slovenia Spain Sweden UK Source: Eurostat ( =de&pcode=t2020_31&plugin=1) 6

8 120,000 jobs on offer in this area (in 2008, there were only 45,000). 5 An increase in workers is also expected for other energy sectors, so that the entire industry is expected to offer more than 2.5 million jobs in 2020, including notable increases until Status and outlook for selected renewable energies One sign of the change, particularly in the EU, is that in % of electricity was generated from wind, water, the sun and biomass. In 2000, the share of renewable sources was only 21 %, primarily due to hydropower plants. 6 More than 60 % of the investments for the expansion of new energy capacities occurs in the field of renewable energy, with nearly 40 % for wind energy (onshore and offshore). 7 By 2050, nearly 50 % of electricity generation from renewable sources will come from photovoltaics (PV), followed by wind energy at about 25 %. The remaining quarter is expected to be distributed among hydropower, CSP (concentrated solar power, solar heat), geothermal heat and biomass. Overall, the EREC (European Renewable Energy Council) estimates an installed capacity of gigawats (GW) from all sources by 2020; this will nearly quadruple to 1956 GW by Due to the expected future market growth of wind energy and PV, we will focus on these segments in the following sections. Wind energy Wind energy plays a prominent role particularly in Germany and Spain. These countries boast 50 % of the installed capacity in the EU. While it was possible to build wind turbines with only 80 kilowatts (KW) capacity in the early 1980s, the output has increased to more than 7 megawats (MW) to date. Currently, facilities with up to 12 MW are being developed for EU power generation 2011 Figure % 0.7 % 0.5 % 13.6 % 6.0 % 10.5 % 5.2 % 23.5 % 25.7 % 0.4 % 0.1 % 13.6 % Source: EWEA, Wind in power (2011 European statistics) offshore operations. The roughly 22,000 onshore facilities that exist in Germany today have an average capacity of 2.5 MW in spite of many older facilities that produce less than 1 MW capacity. Strong growth in the area of wind power is expected to continue; almost 10 GW of wind capacity were generated in Europe and more than 38 GW worldwide in By 2020, a capacity of 230 GW will be installed in Europe. The Asian market, in particular, has shown a massive increase over the last two years. China s share of global growth was 50 %; 9 it also wants to install 230 GW of capacity by Coal Nuclear Gas Fuel oil Peat Hydro Wind Small Hydro Biomass Waste Geothermal Solar PV Power generation from renewable sources until 2050 Figure % 90 % 80 % 70 % 60 % 50 % 40 % 30 % 20 % 10 % 0 % Source: EREC, RE-thinking India, too, is increasingly investing in wind energy in the Asian region, estimating that it create an additional 45 GW by To date, over 95 % of wind capacity in Europe has been generated on land; by 2020, however, the proportion of offshore wind farms is expected to increase to about 25 %. But this does not mean that expansion on land will not continue. New techniques permit the construction of wind turbines virtually anywhere in the world, even in the frigid mountains. The replacement of old facilities, so-called repowering, will contribute to further growth of energy production from wind power. Ocean CSP Geothermal Biomass Hydro Wind Photovoltaics 7

9 Photovoltaics Wind power capacities in Europe until 2020 Figure 5 Large solar farms for generating electricity emerged first in Germany, where along with Italy and Spain most of the energy generated through solar technology is produced in Europe. Italy and the Czech Republic have become rapidly growing markets, especially in the last two years. Outside Europe, Japan, the United States and China are investing heavily in PV. China specified firmly fixed fees for PV power in After the nuclear disaster in Fukushima, the Japanese parliament adopted a law on a feed-in tariff for solar energies; other Asian countries will follow, thus creating the basis for increased investments. in TWh Onshore Source: EWEA Offshore Worldwide, the installed capacity of PV had increased to approximately 67.4 GW by This represents a growth of about 70 % in just one year. Europe has a share of about 50 GW of installed capacity. Purely in terms of figures, about 15 million households can currently be supplied with solar energy. The rapid global developments in recent years show that if political conditions remain the same large investments are also to be expected in the future. Globally, an installed capacity of 131 to 196 GW is estimated for 2015; the 100 GW mark could be exceeded as early as 2013 because, along with Europe, China and North America are driving the expansion. In Europe alone, EREC estimates that 150 GW will be installed by 2020 and 397 GW by By 2050, half of the electricity capacity produced from renewable sources in Europe will come from PV. 10 In the past, the technical development of the modules, the high level of competition (especially from Asia) and the effects of mass production have meant that the cost of PV modules has fallen by more than 50 %. By 2020, prices will again decrease by up to 50 %, according to estimates by the EPIA (European 8

10 Global cumulative PV capacity (in GW) Figure * Source: EPIA Market Report 2011; *estimate Photovoltaic Industry Association); this will facilitate expansion accordingly. 11 Challenges The foundation for the further expansion of renewable energies has been laid. It must be noted, however, that the provision of energy generated using wind and sun is subject to strong fluctuations. On the one hand, the raw materials of wind and sun are not always fully available to produce energy consistently and continuously; on the other hand, the demand fluctuates. The possibilities for storing generated electricity to compensate for capacity excesses and shortages are still limited. Another challenge is the need to expand the energy infrastructure in order to be able to exploit the potential capacities of renewable energy in the first place. Conclusion The concept of using nature, in the sense of wind, water and sun, to utilize the predicted continuously growing energy demand particularly in Asia and specifically in China is not new. However, renewable energy will play an increasingly important role in energy generation due to the finite nature of fossil raw materials. In addition, renewable energy is the key towards being able to sustainably satisfy the various climate objectives. For this purpose, it is necessary to create reliable political frameworks in the areas of research, development and expansion over the long term. Furthermore, the topics of networking markets and the storage of generated energy become important due to the volatile demands for energy. 1 IEA/OECD World Energy Outlook Organization for Economic Cooperation and Development; currently 34 member states. 3 IEA/OECD World Energy Outlook GWEC, China Wind Power Outlook EWEA, Employment Fact Sheet. 6 EWEA, Wind in power, February EWA, Wind in power, 2010 European statistics. 8 EREC, RE-thinking 2050, policy/eu-policies/future-energy-policy-2050.html. 9 GWEC Wind Report EREC, RE-thinking (see note 8). 11 EPIA press release, September 5, 2011; 9

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12 Offshore Wind Energy in Europe Fresh Wind for Insurers, Too? Oliver Stein Oliver Stein is a Senior Underwriting Specialist at Gen Re. He works at the Cologne office of the Global Property Facultative department and is responsible for facultative risks arising from property damage and technical insurance business in Germany. He is a specialist in risks related to the use of renewable energies. Oliver Stein has an engineering degree and has worked at Gen Re since oliver.stein@genre.com Tel: Offshore wind farms promise to become an important energy source in Europe. According to a study by the European Wind Energy Association (EWEA), the expectation is that by the end of this decade wind farms with a capacity of 40 gigawatts (GW) will be erected in European waters (see Figure 1). This represents a tenfold increase compared to the present capacity and corresponds to 8,000 wind turbines at 5 megawatts (MW) each. The offshore wind farms will replace the electricity production of numerous major conventional power plants; as a result, the emission of 102 million tonnes of CO 2 can be avoided. 1 For this expansion, investment of approximately EUR 75 billion is necessary through 2020 (see Figure 2). Without comprehensive insurance protection, however, investors will usually not make capital available for these projects. Thus, insurers have an opportunity to take on a central role in the expansion of offshore wind energy. For them, this represents the development of a new business area, with an important demand for insurance and a significant premium volume. According to our estimates, in the Property and Engineering insurance lines of business the volume of premiums could amount up to EUR 1 billion at the end of this decade (see Figure 3). Even if these estimates contain a range of factors of uncertainty, the indication is that the opportunities and the potential for business are evident. Where are the wind farms to be built? A study by the EWEA 2 identified offshore projects with a capacity of 141 GW in 18 European countries, projects that are to be built in the period reaching beyond 2030 (see Table 1 and Figure 5). By far the largest part is to be erected in the shallow waters and windy areas of the North Sea, whereby the United Kingdom and Germany are already contributing more than 50 % of the capacity. There the wind farms will not solely be located close to the coast; rather, in some instances they will be several hundred kilometres away from the coast and cover large areas of the North Sea. 11

13 Offshore wind power cumulative installations in Europe Figure 1 GW Source: EWEA EUR bn Offshore wind power investments in Europe (without network connections) Figure Source: EWEA EUR bn Annual premium volume for property covers (installation and operation) Figure 3 1,200 1, Source: Estimate Gen Re What challenges do these projects face? In the sea, the wind turbines are subjected to difficult conditions in their surroundings. Apart from wind, waves and salt water, in many instances they will be positioned on a sandy foundation, in water up to 50 metres in depth. For the anchoring of the wind turbines, which are up to 150 meters high and weigh several hundred tonnes, stable foundations are absolutely essential. Offshore wind turbines are getting bigger and bigger. At present, 3.6 MW is the minimum output value for newly built wind parks, and wind turbines of up to 15 MW are already being developed. Whereas the first offshore machines were still modifications of onshore wind turbines, the new wind turbines are being designed solely with offshore operation in mind. Development is proceeding dynamically, and often the past offers little or no experience from which to draw. The production of thousands of wind turbines requires additional production capacity and production facilities, but also requires harbours with corresponding quay facilities and extensive storage areas. For the transport and the erection of the wind power units, special construction vessels (jack-up barges) are used. These lifting ships can prop themselves up at a fixed position in the sea, with legs up to 60 metres long, and install the wind power units using cranes. At present there are only few of these ships in Europe, costing up to EUR 100 million each; consequently, a bottleneck has developed in the process of erecting wind parks. However, additional jack-up barges are under construction, with about 15 scheduled to be completed this year. A schedule of future projects is already planned for them. A further bottleneck is the link-up to the electricity grid. In the case of wind parks not situated in immediate proximity to the coast, the electricity is bundled together in an offshore electric power substation (see Figure 4) 12

14 Planned Offshore Wind Power Capacity in MW (in excess of the year 2030) 3 Table 1 Figure 4: Offshore transformer platform TenneT TSO GmbH UK Germany Norway Sweden Spain France Netherlands Greece Finland Ireland Italy Denmark Belgium Estonia Poland Portugal Latvia Malta Total Europe Source: EWEA 48,596 31,247 11,394 8,279 6,804 6,000 5,992 4,889 4,294 3,780 2,700 2,471 1,857 1, Apart from wind, waves and salt water, in many instances turbines will be positioned on a sandy foundation, in water up to 50 metres in depth. and then transported with a higher voltage to land, via a sea cable. If the wind parks are located more than 50 km away from the coast (as in the North Sea, off the coast of Germany), the electricity from several wind farms is converted into direct current so that the transmission losses do not become too great. For this purpose, additional high-voltage direct current (HVDC) transmission units are essential; these cost several hundred million Euros each. The operators of the electricity grid are responsible for erecting and operating these electricity sockets at sea. If the expansion of HDVC transmission units is delayed, as is currently the case in Germany, it has direct consequences for the construction of the wind parks. What challenges do Property and Engineering insurers face? Prototypes, in particular, constitute an increased risk for insurers. Despite extensive calculations, simulations and tests, the danger of so-called series claims exists, affecting numerous wind turbines of the same type. Hardly any component part does not represent a risk. Apart from problems with the foundations, difficulties have already emerged with the generators, the gearboxes and the shafts of individual models. For the erection of wind parks, sea transportation activities involving major investment of resources are required (e.g., foundations, towers, nacelles, rotor stars, offshore transformer platforms) in addition to the installation of the wind turbines. After installation is complete, the wind turbines are brought into operation on a step-by-step basis, one after another. Important for an insured, therefore, is comprehensive coverage, without any gaps, from manufacture, via transport, through to installation and operation. This requires insurance coverage spanning 13

15 insurance lines of business. Apart from the customary cover modules for onshore risks, this must also encompass special extensions of coverage, such as add-on costs due to bad weather (standby charges) or offshore cancellation costs for the cancellation of contracts for jack-up barges or special offshore construction equipment. Apart from the coverage for property damage, many investors demand coverage against the financial loss resulting from delays caused by property damage during the building phase, or interruptions during the operational phase. Here too, customers seek end-to-end coverage, without gaps, for damages due to interruptions during the phases of transporting, installing and operating the equipment. For underwriting, it is thus essential to have comprehensive know-how of various sectors of business, in addition to specialist knowledge regarding offshore risks, to be able to offer client-specific insurance solutions and having a thorough understanding of the wide cover provided. A further challenge to insurers is the long policy period: Apart from the process of erecting wind turbines, which takes several years, the policies frequently also cover the first one to two years of operation. The Sums Insured involved in a wind park are large. For a wind park with 80 or more wind turbines, they amount to EUR 1 billion or more. Where applicable, several more hundreds of millions of Euros must be added for business interruption insurance cover. The calculation of a Possible Maximum Loss (PML or MFL) is currently subject to great areas of uncertainty, as there are still not yet sufficient instances of experience to take as a basis, nor sufficient calculation models to use. Exposures to large-scale losses arise primarily from the natural perils involved, including, in particular, windstorms and the swell of the sea (also monster waves ), fire damage, instances of impact from ships and series claims due to components in wind turbines. When calculating values, what must be taken into account above all are bottleneck areas with high concentrations of value (e.g., an offshore transformer platform and the export cable, equipment that bundles together all the electricity produced and transmits it to the land). Thus, maximum possible losses can amount to several hundred million Euros for one wind park. And consequently, a high demand for capacity exists, both for an individual wind park and also for accumulation exposures from several wind parks, most certainly because one windstorm can affect several wind parks in one region (e.g., the North Sea). Accumulation risks are particularly problematic for insurers, because a balancing-out effect across a larger number of risks cannot be guaranteed, or can only be guaranteed to a very limited extent. Considering that among the entire investment sum intended for offshore wind parks, ca. EUR 75 billion in 2020, a large part of which is directed to North Sea facilities, the potential exposure to large-scale losses becomes evident. The provision of accumulation capacities is a traditional business segment for reinsurers. Planned offshore wind parks in the North Sea Figure 5 However, what they have to take into account is that significant amounts of liability are already being borne with regard to storm coverages for onshore risks (e.g., residential buildings) in northern Europe. They can accumulate as well if a windstorm event emerges. Accumulation exposures in the North Sea are becoming one of the greatest challenges for the insurance industry, and other options should be considered, such as capacities offered by the financial markets (e.g., securitisations) or governmental liabilities. A further challenge is the scope of coverage demanded by the investors with regard to the insurance for business interruptions. Beyond the immediate loss itself there is demand for cover against contingent business interruption losses with regard to suppliers or customers. Essentially, these exposures relating to offshore wind energy emerge from three areas: Transmission of electricity to the land. (In many countries the responsibility falls not with the wind park operator but rather the electricity grid operator) Manufacturers of components for wind power systems (e.g., wind turbines, rotary blades, sea cable) 14

16 Construction vessels (jack-up barges) If delays or interruptions arise due to property damage at one of the component manufacturers, to the construction vessel or the external installations for transmission of electricity, the idea is that damage resulting from this interruption is also to be compensated. These liabilities can easily reach several hundred million Euros for one wind park. In addition, there also exists a significant accumulation exposure. Only a limited number of manufacturers produce components for wind power equipment, and their production capacities are usually booked out far in advance. In addition, in Germany the electricity from several wind parks is transmitted via one transformer platform and one sea cable. For insurers and reinsurers, it is important to take these dynamics of accumulation into account and to manage the issues involved in a way that corresponds to the available risktaking capabilities of the individual carriers. For example, liabilities can also be managed by agreeing on sublimits for contingent business interruption covers or other relevant accumulation perils. How can we help you in addressing these risks? We are happy to have an open dialogue with you about the opportunities and challenges presented by offshore wind power risks. With our experience in these areas of risk, we would like to support and accompany you in tackling them and jointly benefiting from the business possibilities of fresh offshore wind. 1 EWEA The European Wind Energy Association, Wind in our Sails, November Ibid. 3 Ibid. 15

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18 Liability Insurance for Wind Energy Projects Dmitry Danilin Dmitry Danilin is Senior Underwriting Specialist Second Vice President in Gen Re s Global Casualty Facultative (GCF) business unit in Cologne, Germany. Dmitry has been with Gen Re since 1998 working in different positions in USA and Europe. His focus lies on facultative and programme reinsurance solutions for German and Dutch insurers of casualty risks. dmitry.danilin@genre.com Tel The diversity of various wind energy projects, and the technology they are based upon, can lead to a large number of loss scenarios, which an underwriter must attempt to analyse with regard to the specific project or the insured s function within the context of the project. There are, however, risk elements that are shared more or less by all risks. The following general risk aspects need to be considered when underwriting liability risks of wind energy projects: Location of the risk and its surroundings Activity and scope of service of the insured Location of the risk and its surroundings Unlike property insurance covers, which deal with first-party losses, liability insurance is meant to offer cover for claims arising from losses incurred by third parties. While the likelihood of occurrence and the size of a claim for any first-party loss can be approximately calculated, in the case of third-party losses this is more difficult. 1 Even if a very conservative and less practical assumption were to be made that the likelihood of a thirdparty loss occurrence would be the same as in case of a first-party loss, the size of a loss is initially unforeseeable. The location of the risk, its proximity to third parties and their property, as well as the specific features of the neighbouring third parties and the third-party objects, play an important role because they are the only factors that let us make an underwriting estimate about the level of frequency and severity of losses. Most of the larger wind energy projects are situated in remote areas on land or, increasingly, at sea. This is driven primarily by the fact that big wind farms need substantial space, which is either not available in the wind-rich but densely populated or industrialised zones or can no longer be acquired at acceptable cost. As wind energy systems (WES) are stationary objects, 17

19 night because the emergency power supply of the WES was not functioning and the proper night marking was missing. 3 The ship is severely damaged and sinks even before all the evacuation measures have been completed. As a result, consequential losses arise from bodily injuries and property and environmental damage. Here is another scenario from the area of professional and product liability: An unmanoeuvrable oil tanker collides with the WES. On account of engineering or material defects, the foundations prove to be too rigid, the side of the ship is ripped open and the ship sinks. The foundations and parts of the WES should have been engineered such that, in the event of impact by a ship, serious damage to the ship and release of pollutants would have been avoided. 4 At the moment, WES collision scenarios in shipping and air traffic are less likely, as the number of offshore wind farms is still moderate. 5 One expects, however, a strong increase in the future. 6 This will compromise alternative navigation routes and collision-avoidance manoeuvres, and the collision risk will rise as a result. the relatively large distance from third parties would suggest that thirdparty losses through direct contact with a WES or its parts tend to be rare. The cases of land-based WES having broken rotor components, 2 falling masts or tossing ice provide no evidence of higher likelihood of third-party loss occurrence. Rather, the opposite tends to be the case: some conventional industrial and power generating systems are higher exposed in terms of a risk of liability. With offshore WES, the picture is somewhat different. The likelihood of a third-party loss remains low, but the size of the loss might be substantial. Consider the following scenario: a ship collides with a WES on a stormy The probability of a loss increases as soon as works are carried out in the vicinity of third-party objects, e.g., within the context of building or repair projects. Cable-laying and connection works can cause damage to existing marine cables and pipelines and thus lead to substantial consequential losses (interruption of supply). We shall touch upon the subject of the risks in connection with the erection of the wind farms in the second part of this article. Harm to the environment particularly to marine fauna and flora through wind energy systems is a separate issue. Every building project is surrounded by the environment, so the distance plays a role only to some extent (possibly in the event of a locally confined population of protected species). The general nature of this article prevents us from dealing with the topic of environmental hazards of 18

20 offshore wind energy installations in detail. At this juncture, one would merely mention that the Environmental Liability Directive 2004/35/CE, which has been implemented in the national law of all EU member states, also extends to coastal waters and the territorial sea as well as to protected marine species and Natura 2000 sites within the jurisdiction of the Member States (extending to the exclusive economic zone and continental shelf where applicable). 7 In order to provide for the complete coverage of the insurance, the structure that is based on the designs, specifications and calculations of the insured represents a third-party object. Erroneous design, such as faulty products of the individual component manufacturer that cause damage to the structure as a whole, would thus result in a thirdparty loss. The claim amount will be influenced by the factors mentioned above, and would lead to a higher loss amount for an offshore risk than for a comparable risk on land. The probability of a loss increases as soon as works are carried out in the vicinity of third-party objects. marine environment, a further extension of the territorial scope of the EC Directive is being discussed. 8 A further aspect of the territorial situation of offshore installations is relevant, in particular, to professional liability policies and covers with extended product liability. The major investment effort, logistic challenges and the repair options strongly determined by the weather conditions at high sea are usually mentioned by property insurers as risk factors in connection with offshore risks. 9 For the liability insurers, these factors gain significance when one considers risks of designers and surveyors (professional liability insurance for architects, engineers and surveyors) or risks of the individual component manufacturers (e.g., manufacturers of powertrain or electronic components applying for extended product liability insurance). Within the context of professional liability Activity and scope of service of the insured As already suggested, even if a third-party loss has occurred, the implications for individual concepts of liability insurance vary, because the scope of the insured parties activities also differs. A liability insurance policy can cover various parties involved in a wind energy project as insured and/or additional insured: engineers and structural designers, plant and component manufacturers, building and installation contractors, plant owner and operator, maintenance and repair firms, inspectors and surveyors, and so forth. The policies can cover the entire work of an insured during the period of insurance or insure the liability of several or all parties participating in the single project within the context of project cover. These forms of cover have certain features and dealing with them in detail would be impossible within the context of this article. For that reason, we will only go into the key points here. Activity of the insured 10 On the one hand, the area of wind energy systems and above all offshore WES involves innovative technologies or new applications of existing technologies (e.g., borrowing from the experience of offshore oil and gas industry for the segment of offshore wind farms). On the other hand, it involves systems of high volume. It is thus the work in connection with the system development and production, i.e., the activities of structural designers, engineers and component manufacturers, which is associated with a higher potential for major liability claims. As multiple wind turbines of the same type are built, the loss series problem in the case of engineers and manufacturers plays a pivotal role. There have, for example, already been events with damage to the foundations of WES of certain series, both on land 11 and offshore

21 From the perspective of the liability insurer, construction and installation companies working on erection of wind farms are less exposed than developers and manufacturers. Nonetheless, they can cause substantial third-party losses. There can be multiple claims raised by parties involved in the same project against each other. Project policies that include all parties working on the project often contain cross liability clauses. If an insured takes out cover on an annual rather than a project basis, other parties involved in the construction are in a third-party relationship vis-à-vis the insured. If the cover contains no exclusions for damage to the project work or to the means of transport, plant and machinery used in the project, the insured can be confronted with recourse claims on the part of the property insurers of the third-party items damaged by him. For example, an insured firm of electricians committed faults during the earthing works, leading to damage to the installation when a lightning strikes during the test phase. Due to the high costs and efforts involved in the offshore area, the claims can quickly reach substantial values. The jobs coordination risk represents a further exposure in offshore wind projects. This risk exists in all larger construction projects where different types of jobs are carried out by various parties. The coordination of the Whether he is in a position to assess the various aspects of each job is questionable. Uncoordinated work increases the exposures to a loss; for example, one company designs foundations for the wind turbines to be produced by another company, without fully knowing the parameters and loads of the turbines. The owner s or operator s duty to care for the safety of the WES pertains to the maintenance (continuous monitoring, regular upkeep, safeguarding the proper functioning of day and night marking, etc.) that ensures safe operation of the WES. As wind energy systems usually stand relatively isolated, the operator s third-party liability exposures tend to As multiple wind turbines of the same type are built, the loss series problem in the case of engineers and manufacturers plays a pivotal role. sequence in which the tasks and project stages are performed is a matter for the general contractor. He concludes a contract with the contract principal and engages other companies in the project. Based on our underwriting experience and discussions with representatives of the offshore wind industry, one can state that the institute of general contractor or professional project manager has not yet fully established itself in offshore wind energy projects. There are specific warranty surveyors, who monitor the execution of certain critical works, but they do not completely assume the tasks of a project manager. In the absence of any professional coordinator, that duty lies with the contract principal, who has individual contracts with the parties involved in the project. remain moderate. In practice, a more typical loss scenario includes accidents in which employees of the maintenance and repair companies were killed or injured, and those events were attributed to a breach of the operator s duty of care. A recourse claim on the part of a social security fund, a mutual indemnity association or employer s liability insurer is conceivable, depending on what compensation system for industrial accidents prevails in certain countries. The third-party loss exposure of maintenance and repair companies relates primarily to damage caused to the high-value plant and equipment (without the parts worked upon directly by the insured). A more trivial example is fire caused by sparks during contractor s welding work. 20

22 Such exposures are typical for any contractors. It is, again, the values, the challenging environment for maintenance and repair, and the consequences of long interruption of operation that drive the loss amounts upwards. Scope of service of the insured and limitation of liability The number of large wind energy projects has not yet reached the scale that would allow the insurers any meaningful diversification of risk. These projects, however, carry a higher potential to produce large losses, above all due to the high values of the installations, the means of transport and equipment used in their construction and the costly consequences of any downtime. The parties involved in the projects and their insurers generally recognise these factors. Among the professional parties, there prevails a form of consensus that one cannot completely pass the risks of innovative projects and less proven technologies over to the insurer, the liability insurer in particular. The insured parties must be prepared to carry a portion of the risks and costs themselves. Otherwise, it would be impossible for the insurer to offer the cover for a feasible premium. A basic principle in liability insurance is that damage to the works or services provided by the insured party is excluded from insurance. For that reason, it is important for an underwriter to define precisely the scope of service of the insured. One way to reduce the liability exposure is to limit or even exclude the liability of a party under contract. One can agree, for instance, that a supplier of sub-components is liable for damage, other than damage to the item supplied, only if he has acted with malicious intent or in gross negligence. However, these liability limitation clauses must be carefully checked above all as to whether they are effective under applicable law and jurisprudence (i.e., if these clauses are included in the general terms and conditions of contract, they must be compatible with the law relating to those terms and conditions, and if not included, they must be individually negotiated and explicitly accepted by the parties every time). 21

23 Another method that comes into play now and again in the area of the renewable energies or other innovative segments is contractual hold-harmless agreements in favour of engineers and component manufacturers. In those work areas where no generally accepted state of technology has yet been reached due to a lack of historical empirical evidence, any unrestricted chance to be held liable would represent an unacceptable risk for many a party (consider, for instance, smaller specialized firms assisting in the planning and/or manufacturing of the installations). Based on the appropriate costs-benefits analysis, the principal and his property insurer as this concerns first-party losses can waive any recourse or subrogation rights. Whether the liability insurer can indeed benefit from the contractually agreed limitations of liability in the event of a claim needs to be examined in the course of underwriting. Thus it is important for the underwriter to see copies of the contracts that define the scope of service and the liability of the project parties and take account of them when developing the insurance concept and calculating the premium. One thing, though, is clear: any contractual agreement can be binding only on the parties to the contract and gives no absolute protection against claims by third parties. Apart from agreements made by the parties involved in the project, the delineation provided for in the insurance policy between different insurance products also has particular significance. As the scope of cover offered by the insurers for a wind energy project will normally stretch over several lines of insurance business, it is absolutely essential to draw up an insurance concept that is preferably without loopholes and clearly distinguishing between different lines of business and subject matters insured. For a wind energy project, a complete insurance package is normally effected on a turn-key basis, including planning, design, construction and test phases. Such a package would contain various coverage sections. Therefore, it becomes crucial to draw a line between the scope of cover of the liability insurance on one side, and the items covered by the Engineering and Transport insurance and with offshore projects Marine insurance (hull insurance, P&I, charterer s liability, etc.) on the other. The following must be defined: Which pieces of equipment used and objects constructed within the framework of the project can be attributed to the insured (any damage to those would thus be a first-party loss and a matter for the engineering insurance or business interruption insurance and not for the liability insurance) Whether the first-party insurance in post-commissioning phase includes cover for damage originating from faulty work in the pre-commissioning (warranty cover) Which third-party losses caused by ships or other floating equipment would be covered under Marine insurance and which would arise from exposures falling under liability insurance. 22

24 These are all key questions that need to be answered during the risk analysis and considered when pricing for the cover. Summary The location of the wind energy project and the scope of the insured s services within the context of the project are the attributes that largely determine the potential for a liability claim. Based on those key aspects, further factors of any individual risk can be assessed and accounted for when working on a coverage solution. 1 Attempts have been made to estimate and measure the likelihood of occurrence of a thirdparty loss within the context of planning permit procedures. In the Netherlands, the permit for construction of a WES is only granted as long as certain probability values are not exceeded: < 10-6 for the individual pedestrian risk (individueel passanten risico) and < 2*10-3 for the societal risk (maatschappelijk risico) de Joode, Onnink, van den Horn. Windturbines langs auto-, spoor- en vaarwegen. Beoordeling van veiligheidsrisico s, 15 April 1999, windenergie.nl/files/documents/windturbines_ langs_auto-spoor-vaarwegen.pdf. One example for the offshore area is offered by the standards for risk analysis of the Bundesamt für Seeschifffahrt und Hydrographie (German Federal Office for Ocean Shipping and Hydrography, BSH) and the calculation methods of Germanische Lloyd developed on that basis, e.g. Knust, Dahlhoff, Gabriel, Heuers, Hüppop, Wendeln. Investigations to avoid and reduce possible impacts of wind energy parks on the marine environment in the offshore areas of North and Baltic Sea. Bundesamt, 2003, fpdf-l/2686.pdf. 2 Rotorkopf von Windrad stürzt ab, news report of 19 June 2011 at website/rubriken/nachrichten/indexhessen jsp?rubrik=36094&key=standard_document_ The scenario idea is based on the example quoted in the publication of the GDV: Renewable energies Overall survey of Engineering Insurers within the German Insurance Association (GDV) on the level of technological development and the technical hazard potential. Publisher: Gesamtverband der Deutschen Versicherungswirtschaft e.v. (GDV). Editorial status: 26 May 2010, p. 60 (publication in German Energien_2010_n.pdf and in English gdv.de/wp-content/uploads/2011/11/renewable_ Energies_2010.pdf). 4 Bundesamt für Seeschifffahrt und Hydrographie (BSH). Standard: Konstruktive Ausführung von Offshore-Windenergieanlagen. 12 Juni 2007, p Standard/7005.pdf. 5 In this respect one can refer to the experience of the offshore facilities of the oil and gas industry, which have already existed for a longer time and where collision incidents have been registered over decades. See, for example, Ship/platform collision incident database (2001), prepared by Serco Assurance for the Health and Safety Executive 2003, which contains data for the period 1975 until 31 October 2001: research/rrpdf/rr053.pdf. 6 One can derive the numbers for the future of offshore wind projects in Germany from the information of the BSH. The BSH publishes the overview maps of offshore wind farms already in operation, under construction, approved and planned in the North Sea, de/meeresnutzung/wirtschaft/contis- Informationssystem/ContisKarten/NordseeOff shorewindparkspilotgebiete.pdf and Baltic Sea, see Wirtschaft/CONTIS-Informationssystem/Contis Karten/OstseeOffshoreWindparksPilotgebiete.pdf. 7 Report from the Commission to the Council, the European Parliament, the European Economic and Social Committee and the Committee of the Regions under Article 14(2) of Directive 2004/35/ CE on the environmental liability with regard to the prevention and remedying of environmental damage. Brussels, 12 October 2010, ihmlang=en&lng1=en,de&lng2=bg,cs,da,de,el, en,es,et,fi,fr,hu,it,lt,lv,mt,nl,pl,pt,ro,sk,sl,sv,&val =525377:cs&page=. 8 Ibid. 9 See Offshore Wind Energy in Europe Fresh Wind for Insurers, Too? by Oliver Stein in this edition. 10 On the issue of risk differentiation based on the functions of the parties insured, also see Hille, Schröder, Dettmer, Visser, Offshore- Windkraftanlagen Haftung und Haftpflichtversicherung (especially Teil II, C. Haftpflichtrisiken für Betreiber, Hersteller und Zulieferer von Offshore-Windparks). VersR 2010, p neue energie das Magazin für erneuerbare Energien, no. 11/2008, pp 38. The 2005 annual report of Vestas mentions an extraordinary revision of the warranty provisions, the additional warranty provisions are put at EUR 106 million, Vestas Annual Report 2005, p. 8, com/files/filer/en/investor/financial_reports/ 2005/2005-AR-UK.pdf. 12 Wind turbines certified despite construction error, The Copenhagen Post Online, 7 April Sinking turbines blow ill wind across offshore energy sector, The Times Online, 13 April Repair activities completed successfully, 26 April repair-activities-completed-succesfully-2/. 23

25 24

26 The European Battle Over Sex Human Beings Are Above Statistics Andres Webersinke Andres Webersinke is a Senior Vice President in the Life/Health unit, heading the Research & Development team that combines actuarial and medical/underwriting resources for an improved management of biometric risks. His unit is responsible for Gen Re s various Competence Centres formed for protection products and underwriting manuals. In conjunction with the Business School, the unit offers a wide range of certified training courses. webersin@genre.com Tel Insurers in the European Union (EU) were busy preparing themselves for the new Solvency II regulations when the European Court of Justice (ECJ) surprised the industry with its judgment on March 1, 2011 to end gender discrimination in insurance, which was aimed at supporting the fight against unfair discrimination. Insurers, the public, politicians and lobbyists all have the same basic idea of eradicating any form of unfair discrimination, but it is once again the method by which this was achieved that was disturbing. It underscores the need for a more vigorous response by the industry in addressing such issues as fairness and transparency. What happened? A brief summary To refresh memories, in 2003 the European Commission adopted a directive proposal for implementing the principle of equal treatment between women and men in the access to and supply of goods and services. During the various stages of consultation, we witnessed several controversial discussions. Nevertheless, the European Commission did not yield to the request to allow gender-specific calculations of premiums and benefits for the purposes of private insurance within Europe. In other words, back in 2003 the European Commission had already insisted on unisex rates. Since this meant a significant change in the usual practice, a transition period was offered for implementation, and furthermore, this equal treatment rule was only to apply to new business. Some Member States lodged objections, but finally all consented to the socalled Gender Directive (2004/113/EC), passed on December 13, , albeit with some changes. Article 5(2) of the directive provided an exemption from the principle to eliminate gender discrimination for insurance contracts subject to special derogation rules: gender is a determining factor differentiation must be based upon accurate and published data national parliaments had to implement such an exemption prior to a set deadline 25

27 Where gender as a rating factor is already disallowed by national law 2 Table 1 Belgium Bulgaria Cyprus Estonia Ireland Latvia Lithuania Netherlands Slovenia Life Annuity Disability LTC Critical Illness Travel Accident Motor Member States shall review their decision every five years, taking into account a report presented by the European Commission. Looking at eight main product lines, Table 1 lists those EU Member States that explicitly disallow gender-specific insurance pricing in some cases. Whereas all 27 EU countries opted for an exemption for life and annuity business, nine nations insist on unisex pricing for some product lines, most often in the case of motor insurance. Some countries, most notably Belgium, limited the use of gender in pricing insurance premiums to a bare minimum. This set the scene for what came next A legal process was initiated by a Belgian consumer organisation and, it should be added, by two men challenging the derogation as incompatible with the EU Treaty. The Belgian Constitutional Court took the case (C-236/9) to the ECJ to decide on the validity of the exemption from the prohibition of all gender discrimination for the insurance industry. The March 2011 verdict rules that Article 5(2) is invalid with effect from December 21, From this date onwards the use of gender as a factor in calculating 26

28 insurance premiums and benefits will be banned in the EU. Given the history of the directive, the judgment is no surprise. The insurance industry underestimated the desire of the European legislative and judiciary to promote equality between men and women in all activities. The directive offered no more than an exemption. The fact that almost all Member States implemented this exemption for almost all lines of insurance lulled the insurers into believing that there would be no change from what seems like a perfectly fair, reasonable and well-understood approach to risk differentiation. fuelled by the understanding that it should not prove to be too difficult to aggregate two pricing tables. All that is needed is the right gender mix. Calculating the gender mix The simplest solution would be to start with the most conservative pricing basis. However, in a competitive environment or in cases where the final premium heavily depends upon the gender, a new pricing factor is needed the gender mix. The assumption on the gender mix requires a careful assessment equal to all other pricing assumptions. Past experience bonuses and privileges for employees. Annuity providers developed qualifying plans accordingly the so-called Riester-Annuity (named after the politician who devised the scheme). In order to qualify, plans had to be gender-neutral from the beginning of Figure 1 shows that this change lead to a last minute sale to men in Having said this, the share of policies sold to men in 2006 was not any different from The fact that these plans are low premium policies and state-funded will affect the buying-behaviour differently to what can be expected for other insurance plans following In 2003 the European Commission adopted a directive proposal for implementing the principle of equal treatment between women and men in the access to and supply of goods and services. The industry s reaction It is somewhat remarkable to note that the insurance industry s answer to this judgment was little more than a shake of the head. Its focus was more on the exact implementation of this ruling and only on where it mattered most (in biometric risks, such as death, longevity and health). Admittedly, the ECJ did not argue with the fact that statistics showing differences between men and women are merely used as a proxy for differences in lifestyle and behaviour; rather it referred to fundamental rights enshrined in the EU Charter, making it difficult to argue for a different position. This along with a lack of political will to re-open a drawn-out discussion already held in indeed directed the industry s focus on accepting and implementing the ruling. The moderate reaction of the industry was perhaps is always useful but with the entire industry switching simultaneously, evaluating the competition and changing customers behaviour will be particularly challenging. Changing customers behaviour In 2001 the German government introduced a pension plan with state Proportion of Riester plans (unisex since 2006) sold to men based on a Gen Re analysis amongst several German insurers Figure 1 54 % 52 % 50 % 48 % 46 % 44 % 42 % 40 % the ECJ ruling. In any case, the need for financial protection is not going to change. For sure the ECJ judgment will be used by agents and brokers to sell more annuity business to men in the last months of Similar effects can be anticipated for other products sometimes increasing the share of

29 men and other times that of women. The opposite may then take place in early This will have unpleasant consequences for reserving purposes, for example, since the gender mix assumption will reflect the mediumto long-term expectations. Data analysis These expectations can vary significantly from office to office. Looking at immediate annuity business and separately at term assurance, Gen Re conducted an analysis of data from over 20 German life insurers. The following is a brief summary of the results. Proportion of men in immediate annuity business (top 7 immediate annuity writers within the Gen Re datapool; only policies in force for less than 10 years) Figure By number: min. 44 % max. 72 % By sum: min. 51 % max. 77 % AII A B C D E F G Figure 2 depicts the proportion of men (by number of policies and weighted by sum assured) for immediate annuity business. About 50 % of immediate annuity plans were sold to men, but weighted by sum assured, the proportion of men is just over six percentage points higher. The variation even amongst the larger players is significant. The weighted proportion varies between 52 % and 59 % amongst the top four writers. The maximum proportion of men increases to 77 % if the next three top insurers are included. This clearly demonstrates the need for a careful analysis of the data. Whereas immediate annuity business is sold in almost equal shares to men and women (over all companies), this cannot be said for term assurance. Here the proportion of policies sold to men is over 60 %. Weighted by sum assured, the share increases by three percentage points. A reason for the narrower relationship could be the lower premium level charged to women. However, surprising again is the significant differences from one insurer to the other. Whereas one insurer must calculate with a 23 % share of female customers, another will benefit from a rate that is twothirds higher and almost a 40 % share (Figure 3). The gender mix for life insurance also depends on the entry age and duration. Men typically start owning life insurance cover later in life than women, affecting the chosen duration. However, insurers should also analyse how the gender mix is changing during the duration of a policy. Lapse rates, for example, may be different and thus change the mix over time. The gender mix for annuity and longterm care policies will change significantly with increasing duration as higher mortality and morbidity rates reduce the share of insured men paying premiums. Other factors influencing the proportion of male customers are the target market, build-in options (may be exercised differently by men and women), trends (e.g., as a result of an increasing employment rate amongst women) distribution channel, etc. It can be expected that brokers will sell higher sums assured to more men, whereas the banking channel will sell more annuity business to women than men (at least in the German example). Beyond the gender mix Where premium competitiveness is key, a new mindset is required. How can an insurance company selling term assurance via direct marketing attract more women, in order to have an overall attractive premium level? How can a bancassurer ensure that annuity business is sold as expected to both men and women? One answer to these questions is to introduce new attributes, with the 28

30 Proportion of men in term assurance business (top 9 term assurance writers within the Gen Re datapool; only policies in force for less than 6 years) Figure By number: min. 59 % max. 72 % By sum: min. 62 % max. 77 % AII A B C D E F G H I As such, the concerns around the gender mix require some managing and steering to ensure the actual gender mix is aligned or is better than the mix used in the premium calculation. This may be achieved by means of innovative product design, better use of target group typology, targeted sales documentation, discounts for partner policy and appropriate sales incentives, to name a few. This is familiar ground for sales and marketing experts. Having said this, other industries, such as the car or grocery sector, are ahead of the insurance industry in terms of influencing and understanding the buying patterns of customers. aim of accurately pricing the risk categories and thus offering fair and competitive terms to the target market, avoiding indirect discrimination, of course. Motor insurance is a good example. In the group of young vehicle drivers (below age 25) men have a higher claims index than women (in Germany the claims ratio is between 25 % to 33 % higher 3 ) but already today many motor insurers use carefully chosen criteria to distinguish multiple risk categories. Gender is not the sole key differentiator. This is different for most life insurance products. Gender differences typically remain with increasing age and across most medical conditions. But the principle for further differentiation is also well understood in life insurance. Insurers offer lower premiums to so-called preferred lives (in the case of mortality or morbidity cover) or enhanced annuities to people less healthy than the average person seeking a regular income at retirement age. One can expect increasing activity in this area but not a sudden switch or rapid movement towards new types of risk categorisation. After all, established insurers cannot afford to target men or women alone. Both sexes are part of a typical target market and unless the current target market is completely changed, new attributes will only be introduced over time or where competitiveness is affected by the court ruling in particular by those companies who have too much of the wrong sex. Open questions answered? The judgment itself is unmistakable. However, a closer examination of the consequences opens up a number of questions. Particularly noteworthy are the questions of its applicability on individual risk assessment in life insurance as well as to existing business. Both issues had been addressed in the guidelines on the application of the judgment published at the end of 2011 by the European Commission. 4 These guidelines shall facilitate the compliance with the judgment at national level. Having said this, the Commission s position is without prejudice and the ECJ may well have a different interpretation if asked. 29

31 Already the original draft of the Gender Directive was meant to affect only new contracts. In line with these original objectives, the European Commission made it clear that it wants to avoid sudden readjustments and thus confirms the interpretation that the ruling applies only to new contracts, i.e., those policies that are concluded on or after December 21, 2012 or existed but a contractual agreement requiring consent by all parties is made on or after this date. The assessment of so-called substandard risks requires at times the consideration of the applicant s gender. In Critical Illness insurance, for example, a family history of breast cancer may lead to a specific exclusion or additional premium for a female applicant. For men, however, the decision may be a different one as the relevance of this risk-contributing factor is dissimilar. It seems inappropriate to apply in all cases the same underwriting decision so as not to differentiate between the sexes, or better said, not to discriminate between the sexes. To protect the insurer and the pool of existing policyholders against antiselection, the applicants for larger sums assured typically undergo a series of medical and laboratory tests as part of the underwriting process. The interpretation of the test results depends on the combination of risk factors for a disease and the pre-test likelihood of this disease. A younger female has a significantly lower pretest likelihood for coronary heart disease than a man. Consequently, gender influences the positive predictive value of a cardiac stress or exercise test. The interpretation of such a test result should not be considered without the gender information to avoid labelling a healthy applicant sub-standard. This list of issues can be extended to include different laboratory norm values for different sexes, different medical tests requested for men and women, etc. The Commission s position confirms that in light of physiological differences between Every decision not to pay the full claim amount should receive a thorough examination on fairness. men and women, differentiation is possible on other risk factors (for example health status) than simply gender. It is critically important that the way the industry goes about individual risks assessment does not change. Having said this, additional premiums for unfavourable health conditions are calculated comparing standard risks with that of a diseased population. Even if the relative extra mortality is the same for both sexes, different disease prevalence amongst the sexes will result in an imbalance of the total extra premium charged across a portfolio, if these loadings are applied to unisex rates. Summary The ECJ judgment on gender equality has a number of immediate and longterm consequences for the industry. Whereas the court s ruling does not find much favour with insurers and even the general public, the European Commission s guidelines on the application of the judgment has eased the tension somewhat they are mostly practical. It is perhaps the general tone or attitude the industry faces in the debate on antidiscrimination which causes frowns. The European Committee on Women s Rights and Gender Equality had a first debate on the ECJ judgment and its implementation on May 25, 2011, providing a first glimpse into the thought process of decision makers. 5 The committee s Rapporteur (Zita Gurmai, Group of the Progressive Alliance of Socialists and Democrats in the European Parliament) made it clear that the ECJ s decision was a very important one and that she will make sure 30

32 that consumers will not pay higher premium rates for not being discriminated against. Other opinions ranged from underlining the principle of the fight against discrimination being more important than economic consideration (as voiced by Raül Romeva i Rueda, Group of the Greens/ European Free Alliance and Rapporteur for the outstanding anti-discrimination directive on age and disability) to the pragmatic question of What do we try to achieve? (as asked by Marina Yannakoudakis, European Conservatives and Reformists). While this debate is ongoing, insurers should be preparing for the new unisex environment. This will definitely include the analysis of the gender mix in new business by the various factors described above but also the effects this has on reserving. Which reserving basis should or can be used in future? Insurers should maintain a degree of flexibility in order to react swiftly should competitors introduce innovative product ideas or use new attributes with better risk selection effects. This will require new management tools to monitor the gender mix for both reserving purposes and new business development. The long-term effects, however, should also be considered. The notion of the right to underwrite is once again being openly debated. Categorisation of risks is the provenance of private insurers; however, the EU continues to debate the insurer s right to differentiate risks by age and disability. Some politicians and lobbyists gained impetus from the recent ECJ ruling on gender. Sooner or later this will impact other jurisdictions with perhaps similar results. The insurance industry is being called upon to make its processes more transparent. Every decision to rate or decline a risk, every decision not to pay the full claim amount should receive a thorough examination on fairness. At the same time, the industry needs to organise itself better and across national boundaries to educate the decision makers and lobbyists about the way risks are assessed and how competition ensures that more and more individuals almost everyone in the society can have access to financial protection products at a fair price. 1 The Directive entered into force on December 21, 2004, giving the Member States a period of three years to implement the provisions into national law. 2 CIVIC Consulting. July 16, Study on the use of age, disability, sex, religion, or belief, racial or ethnic origin and sexual orientation in financial services, in particular in the insurance and banking sectors Part III: Annexes. 3 Based on calculations from the German Insurance Association (GDV): Themen/LebensversicherungAltersvorsorge/ Produktfragen/Beruecksichtigung_des_ Geschlechts_bei_Kalkulation/inhaltsseite html, accessed on August 19, European Commission. Guidelines on the application of Council Directive 2004/113/EC to insurance, in the light of the judgment of the Court of Justice of the European Union in Case C-236/09 (Test-Achats). C(2011) 9497 final. Brussels, December 22, Parliamentary Committee Meeting. Event: Committee on Women s Rights and Gender Equality (FEMM). Brussels, May 25, 2011, 09:14-10:55, accessed through the multimedia library ( multimedia-library/). 31

33 Yonder Lies the Way or How to Manage Process Risk in Insurance Sales Astrid Kahl Astrid Kahl joined Gen Re on Sept 1, She achieved a master degree in economics and insurance business and worked for a primary insurer in various positions on the reinsurance and life side. She is in charge of the client service unit being responsible for life and health underwriting, the development of underwriting and claims systems as well as claims management and the claims visiting service. astrid.kahl@genre.com Tel

34 Process optimisation or enhancement is a topic that direct insurers must increasingly deal with to combat the rising cost pressure and improve their services. All areas are analysed and opportunities sought to streamline and speed up processes, and thus also to meet the growing expectations of the customers. Particular attention is devoted to processes around distribution; the intermediary is the first point of contact the customer has with the insurer. The sales process, however, is embedded in a complex legislative framework. In this context, topics such as data protection, anti-money laundering and responsibility for the intermediary s actions are just a few examples that come to mind. While not discussed further in this article, those issues nevertheless need to be taken into account in any decision on process design. Risks in the sales process The sales process begins with a customer needs analysis and product advice based on that analysis. This is where the first friction can occur. Already the product design has an influence on the sales process and can cause problems. On closer examination 33

35 of the overall process, it becomes clear that a number of factors have to intertwine like clockwork to achieve a perfect result. Let s take a look at the chain of process steps from product development through to the issue of a policy and pinpoint potential problems. Bad advice The products should not only be tailored to the customer s specific needs but also easily understood by intermediaries and customers alike. Clarity as well as a high degree of transparency in terms of the coverage and benefits of the product can prevent misunderstandings and reduce the risk of bad advice. An intermediary who does not understand the product, its content and target groups may give the customer wrong advice. As a consequence, the customer may have a claim for damages from professional negligence and lose his trust in the insurance company. In the worst-case scenario, the consequences can be loss of earnings and reputation for the insurance company. If the product and process mesh well, the overall process becomes more efficient. Handling the case will be easier and the distribution channel will have additional sales incentives. Data transfer/transmission errors Next, attention must be directed towards the operational processes and the associated risks. These include all processes from the initial consultation of the customer through to the issuing of the policy. Depending on whether the expert advice takes place using supporting computer programme in the intermediary s office or paper 34

36 If the product and process mesh well, the overall process becomes more efficient. documents in the customer s home, the first data or media disruption can occur here, meaning the switch from one medium (e.g., IT system/quotation software) to another (e.g., printout of the quotation on paper) can cause errors. The design of the user interface and data entry screens of the needs analysis tools and the quotation software are not always comparable or even linked to each other. Multiple entries of data are often necessary, and owing to the different logical structures and a switch between media, this can lead to transmission errors. If the customer accepts the quotation, an application for insurance will be submitted. If the data from the quotation are not automatically transferred to the application, the data entered on the application form is at risk of being erroneous. The application signed by the customer is then sent to the head office. If this does not take place by way of electronic data transfer, the process is prolonged by the fact that the paper form has to be scanned, imported or even re-entered manually. Manual input is both costly and timeconsuming, and, again, entails the risk of transmission errors. Workflow design and effect on process time Depending on the organisation or the workflow design, clean cases result in policies being issued automatically, meaning without any further manual intervention. The remainder of the cases are dealt with by the new business department. Decisions will be taken, documents requested, a tele-interview arranged or the application passed on to an experienced underwriter. Within the new business department is the risk of not taking the appropriate decision due to a perceived uncertainty with the application at hand. To a large extent, this depends on the staff members involved, on how clear and precise guidelines and instructions are, or on the technical support. Quite often, a large number of cases end up being passed on to the underwriting department. Tele-interview and tele-underwriting In a tele-interview a service agent asks the customer about his or her state of health as a follow-up to the application. The customer receives a written report on the content of the interview, which he is normally required to sign and return. Only then can the policy be assessed and possibly issued. The risks here are related, on the one hand, to the finding of an ideal third-party provider and, on the other, to the development of scripts with appropriate questions that enable a valid risk assessment. Concerning the second point, the use of an expert system can be supportive. 35

37 Depending on the respective sales channel, there may be good reasons for using tele-interviews, but it is more time-consuming than the normal process as the interview report has to be sent to and then returned by the customer after signing. Tele-underwriting goes one step further than tele-interviewing: The decision regarding the risk, based on the answers given by the customer, is taken during the telephone conversation and communicated to the customer. Tele-underwriting is normally carried out by a third party or the insurer s underwriters. Just as in the case of tele-interviewing, a report is prepared and sent to the customer for signature. For legal certainty, the insurance company waits until the signed report has been returned before finally issuing the policy. How promptly the customer returns the report determines the overall processing time. Outsourcing If the insurance company decides not to do in-house underwriting, the choice of the third-party provider is already fraught with a certain risk: Does the provider understand the business just as well as the company itself? Are the decisions made consistent and above all in line with its underwriting guidelines? Are there changes as to the acceptance rate and the quality of the risk assessment? Which audit options exist? The use of an expert system by the third-party provider ensures consistent underwriting decisions and helps the insurance company monitor and manage these decisions. To date, the most common procedure is to underwrite the remaining complex cases in-house. Accordingly, new and inexperienced underwriters need explicit instruction. The clear delegation of authority or referral to manuals is crucial for correct assessment and appraisal of the insurance risk. On the basis of available documents, experienced underwriters can reach a decision faster and issue the policy, or they can identify and request additional information needed to make the final assessment. The workflow at head office and the interaction with third-party providers thus have a crucial influence on the time needed to issue a policy. How can the insurer face up to these risks? By now it should be clear just how complex the new business process is, where and how many switches from one medium to another take place, and how these factors make the process more complicated or lead to more errors, thereby slowing down the entire process. The longer the process takes from preparing the quotation through to the issuing of the policy, the more discontented the intermediary will become because of the delay in receiving the commission, and the more inclined the customer will be to think twice about his insurancebuying decision. As customer surveys and empirical figures have shown, customers expect to receive their policies within a few working days of submitting their applications. 36

38 The inclusion of local sales managers in the training courses has proven to be a very successful step. Increasingly, insurance companies are busy optimising their new business processes, often aiming for straightthrough processing systems, starting with a point-of-sale component. These help them achieve a lean process with standard interfaces and no media switches, along with faster processing times. According to our own observations, the process becomes efficient if an expert underwriting system is used at the point-of-sale and is integrated in the quotation software. With the aid of dynamic questions, customers can answer the health questions necessary for a risk assessment and (when needed) send in a medical report right there and then. The intermediary comes across as competent and is in a position to Fast and efficient processes ultimately lead to lower premiums, improved sales opportunities and greater customer satisfaction. Summary Sales personnel and customers may have different interests, but they have similar expectations. Both can be convinced by clear, easily understood products, fast turn-around times and a continuous improvement of services. Process optimisation can help in achieving these goals. Processes have to be thought through from start to finish, allowances made for the particularities of the sales channels, all interfaces taken into account and media switches avoided as far as possible a task that truly is far from easy. Those direct insurers who have analysed their processes accordingly and adapted them with the help of technical aids have not only minimised a large number of the risks but have faster processing times and despite the initial investments reduced their expenses in the interim. Fast and efficient processes ultimately lead to lower premiums, improved sales opportunities and greater customer satisfaction. Product design and advice-related risks can be minimised in two ways: by a simple, gradual and logical product set-up (a kind of modular system) and through extensive technical support with built-in plausibility checks within the needs analysis and quotation software for the intermediaries. Depending on the complexity of the product, it is often sensible to provide not only the standard introductory documents but also a comprehensive training programme for the sales personnel. explain and communicate the decision to the customer on the spot. In this process, the application is electronically transmitted to the head office, resulting in a policy being issued, in most cases, within a very short time. Many of the process risks discussed here can be eliminated by measures described above, while also considerably reducing process times and offering better customer experience. 37

39 Periodic Payment Orders in the UK A Reinsurer s View Mike O Dea, Ines Hellmayr and Geoff Piggot Mike was appointed the Chief Financial Officer of the London Operations of General Reinsurance in April 2012, having also held the position between 2002 and Prior to his current role he was the UK Treaty Regional Manager. He is also the Principal Officer of the London Branch of General Reinsurance AG. Ines has worked since 1995 for Gen Re as a Non Life Treaty Underwriter. She joined the UK Treaty team in April 2011 as the Chief Underwriter. Tel. +44 (0) ines.hellmayr@genre.com Geoff is a Regional Claims Manager based in our London office. He has spent many years handling motor Bodily Injury Claims from both an insurance and reinsurance perspective. Tel. +44 (0) gpiggot@genre.com Tel. +44 (0) mike.odea@genre.com 38

40 Periodic Payment Orders (PPOs) have become an increasingly common occurrence in the settlement of higher value bodily injury (BI) claims in recent years, particularly those with a value in excess of GBP1m. Under PPOs, claims are settled by way of an initial lump sum amount to ensure that the claimant is able to adjust to their new circumstances and lifestyle, together with an agreed annual payment (which is indexed), usually to cover future care costs. This article discusses the key considerations as we see them: Frequency of PPOs Impact of mortality and inflation on claims costs to the reinsured and reinsurer Operation of the index clause in reinsurance treaties Greater importance and sensitivity associated with investment returns All of these factors increase the inherent uncertainty associated with the ultimate value of PPO claims. With non-proportional reinsurance treaties exposed for the large part to higher value BI claims, we believe that this should lead to higher premiums being charged by reinsurance markets. We have also used this opportunity to comment briefly on the accounting treatment of such claims as well as the increasing debate on capitalisation clauses. The background to periodic payment orders Historically, the closest method of claim settlement to PPOs was known as structured settlements. They were very different from PPOs in that a lump sum settlement amount was calculated and had to be agreed by both Claimant and Defendant ( the Parties ) before an annuity was purchased. In April 2005 Courts in England and Wales were given the power to impose PPOs without the consent of the Parties. 39

41 The annual payments under a PPO are the same as those on which a lump sum settlement is calculated. This meant that the court had to focus on whether a PPO, in the form of indexed annual payments over time as opposed to an immediate lump sum settlement, was appropriate and best met the needs of the Claimant. Although the introduction of the Court s ability to impose PPOs attracted considerable publicity in 2005, few cases were initially settled in this way. It was not until 2008 that increasingly significant numbers of cases began to settle as PPOs. This was due to a number of reasons. The future cost of care for the Claimant, allowing for inflationary pressures The Claimant s life expectation and specifically by how much this has been reduced as a result of the accident The discount rate to be applied in converting the projected future costs into a corresponding lump sum amount. The current precedent (referred to as the Ogden Tables) assume that the Claimant will receive a real rate of return of 2.5 %. Inevitably, all these assumptions require a certain degree of speculation that result in lump sum settlements being imprecise. flow benefits through the replacement of large upfront payments with a smoother profile of regular payments over a longer period of time. However, they also assume the not insignificant risks of increased life expectancy, care cost inflation and volatile investment returns. Just as importantly from our perspective, reinsurers face the same risks on a leveraged basis when writing non-proportional treaties. Frequency of PPOs Whilst all classes of casualty insurance are exposed to PPOs, to date the vast majority of PPO settlements have involved either motor or clinical The clear benefit of PPOs to the claimants is the certainty that funds will be available for their lifetimes without having to worry about their care costs and investment returns. The worldwide financial crisis at that time meant that PPOs appeared to provide claimants with the best option of securing their long-term financial position. Further, the debate over what rate of escalation to apply to the annual payment amounts was resolved by using an index that Claimants lawyers were satisfied with. Finally, judges, lawyers for both Claimants and Defendants, as well as insurers have become more familiar and comfortable with the process whereby claims are settled by way of PPOs. The rationale for settling claims through the PPO mechanism is compelling. In order to settle a claim on a traditional lump sum basis a series of assumptions have to be made, particularly with respect to: For example, if the Claimant lives longer than assumed, or the care costs are more expensive than anticipated due to inflationary pressures, then there is the risk of under-compensation and the Claimant may have to fall back on the State for care. If the Claimant dies sooner than expected then the Claimant s relatives effectively receive a windfall gain. Similar issues arise if the Claimant achieves a real rate of return that is either below or above 2.5 %. The clear benefit of PPOs to the claimants is the certainty that funds will be available for their lifetimes without having to worry about their care costs and investment returns. This is obviously subject to the credit worthiness of the defendants insurers, who themselves gain cash negligence claims. There are a number of reasons for this, including the frequency of catastrophic injuries arising from motor accidents and clinical negligence, as well as the security of the NHS and its desire to settle claims on a PPO basis. Further, the unlimited liability protection provided by motor insurers means that insurance cover will not be exhausted, as is the case in other areas such as Employers Liability insurance. As noted earlier, we have seen a significant increase in the number of cases being settled by PPOs since The question for insurers is whether this is a temporary phenomenon or a trend that is likely to continue in the long-term. It is possible that an improvement in economic conditions 40

42 may lead some claimants and their advisers to view lump sum settlements as more attractive, with the possibility of making significant returns by investing the lump sum. Claimants often want to end their involvement with the insurer and start the next phase of their life. Although this is an option for some claimants, it is unlikely to be the case for the most severely injured. In cases involving minors and claimants lacking capacity, it is the Court that will ultimately decide whether a PPO is appropriate or not, and it will clearly be attracted by the financial security that PPOs offer. In addition, older claimants with a short life expectancy are also likely to see PPOs as more attractive, since the financial implications of them living even a few years longer than expected are significant. We currently have 75 cases reported to us by our cedants with a From Ground Up ( FGU ) reserve of greater than GBP5m at current values. Of these cases, 67 % involve claimants with severe head injuries and a further 20 % involve adult tetraplegia. These are the cases where the Court will be seeking to provide security of future care to claimants and we therefore believe that up to 80 % of FGU claims currently reserved with a 2.5 % discount rate in excess of GBP5m will settle as PPOs. Mortality A key driver of the ultimate cost of PPOs is the Claimant s life expectancy, which means that mortality risk is an important consideration for insurers. We have typically seen two methods employed to estimate claimants life expectancies. Both methods start by looking at the predictions given by the medical experts who are instructed by the claimants and defendants insurers to assess the claim. Unsurprisingly, the experts often disagree and so an average is usually taken as the starting point. The method most commonly used (deterministic) simply takes this average as the point estimate of the Table 1 Increase in Assumed Life Expectancy Total Increase in Incurred Reserve Percentage Increase in Incurred Reserve +1 Year GBP7m 2 % +5 Years GBP36m 10 % Normal life expectation Source: Gen Re (General Reinsurance AG, London Branch) Claimant s life expectancy. We believe this to be insufficient as it is highly unlikely that the Claimant will die exactly at that time. The other method used (probabilistic) is to take the point estimate and create a probability distribution around it, based on mortality expectations. This is statistically more reliable and we would make two specific observations in this respect. It is clear that the second method will allocate some level of claims exposure to higher layers of reinsurance programmes, given that a probability is attached to the Claimant living for a considerable period of time. Secondly, with a real rate return of 0 % (in other words, where future investment returns match inflation) both methods result in the same FGU reserve. Where the real rate of return is positive, the second method results in a lower reserve. The converse applies where the real rate of return is negative. Our experience is that there tends to be less divergence of opinion over the life expectation of claimants with spinal injuries as we have seen more research and a greater understanding of their impact on life expectation. However, there is greater debate and differing opinions concerning claims involving severe head injuries. Our limited experience to date has shown a relatively low frequency of claimants dying earlier than expected GBP76m 20 % so the potential cost of claimants living longer than expected should not be underestimated. We looked at the impact of this risk on a sample of 57 settled PPOs with a combined FGU value of GBP375m and 41

43 Table 2 displays the impact of each example on a reinsurance contract in excess of GBP10m. On a lump sum basis, none of the examples would impact this programme, with the highest ground up claim amount being GBP9.5m. However, if the claims are settled on a PPO basis, all examples (assuming the probabilistic basis of assessing the ground up claim) would affect the contract excess of GBP10m, regardless of the discount rate. Claims inflation this is summarised in Table 1, which shows that the mortality risk transferred to insurers and reinsurers is potentially significant. Impact on excess of loss As noted earlier, lump sum claims are discounted for the time value of money at a real rate of return, currently 2.5 % in accordance with the Ogden Tables. If PPOs were discounted at the same real rate of return, their discounted value would be the same as under a lump sum award. However, PPO claims are covered by the reinsurance programme on an undiscounted basis, thus impacting higher layers that would have been unaffected if the same claims were settled on a lump sum discounted basis. Some examples of the difference in cost between lump sum awards and PPOs are shown in Table 2. For simplicity it has been assumed that the Claimant is aged 22 at the time of the accident, the PPO settlement is agreed in the same year and that inflation will be 4 % per annum. (Even though in reality the PPO settlement is only achieved several years after the accident year, the effect is still the same as described herein.) The term life expectancy means the age at which the Claimant is expected to die. For each of our examples we have evaluated the undiscounted ground up claim on a probabilistic basis, the method which we believe is the more statistically reliable approach. However, for comparison purposes we also show the equivalent numbers on a deterministic basis. We also compare the discounted reinsurance loss at 6.5 % (2.5 % real rate) in accordance with the Ogden Tables with an alternative at 3 % which we consider to be a more realistic assumption for the future as we discuss in the Investment Return section. Table 2 Example 1 Example 2 Example 3 Lump sum element of PPO 1,700,000 2,000,000 2,500,000 Annual payment 150, , ,000 Life expectancy Remaining years after settlement Undiscounted FGU value probabilistic 13,264,282 21,895,823 42,226,161 Cost to R/I layers excess GBP10m Undiscounted 4,471 2,331,921 15,171,472 Discounted at 6.5 % (2.5 % real rate) Discounted at 3 % (-1 % real rate) ,197 1,000, ,657 4,077,587 Undiscounted FGU value deterministic 11,631,429 19,194,067 37,315,802 Cost to R/I layers excess GBP10m Undiscounted ,580,766 Discounted at 6.5 % (2.5 % real rate) Discounted at 3 % (-1 % real rate) General price and wage inflation is a problematic issue for insurers and reinsurers at the best of times, given the long tail nature of many lines of business, particularly those involving large bodily injury claims which typically take five to ten years to settle. This inherent timing risk is exacerbated by PPOs, under which payments will span the Claimant s lifetime. Predicting the level of future inflation and therefore the ultimate cost of the claim in such circumstances becomes extremely difficult ,000, ,620,898 Lump sum with Ogden Table 2.5 % 5,063,728 6,873,677 9,508,739 Cost to R/I layers excess GBP10m *If you are interested in the full calculations, please send a request to goingdirect@genre.com. 42

44 The Court of Appeal has set a legal precedent that the relevant measure of inflation applied to periodic payments in relation to care costs is the Annual Survey of Hours and Earnings (ASHE) 6115 at various percentiles rather than general wage inflation. ASHE 6115 is a survey of the hourly wage costs of care workers, from which an index can be created. As a survey, its construction is not as robust, reliable and timely as general wage indices, and it could also be affected by anecdotal evidence. Claims Inflation Graph 1 Index Source: Gen Re (General Reinsurance AG, London Branch) Historically ASHE 6115 has been consistently higher than general wage inflation. Graph 1 shows a comparison of ASHE 6115 at the 75th percentile with wage inflation over the past 10 years (both rebased to 100 in 2001), which have averaged 4.4 % per annum and 3.7 % per annum respectively. This difference is partly explained by a greater demand for carers and other medical workers for an increasingly ageing population and increased government spending and care provided by the NHS. In addition, the growth of private medical care over the past decade has kept wages high. Mitigating these factors has been an influx of care worker labour from overseas. Forecasting future inflation with any degree of certainty is extremely difficult. We believe that wage inflation for care workers will remain high, as a result of the continued changing demographics of an ageing population, increased demand for childcare as more people return to work, improved medical treatments requiring more specialist and trained workers, and last but by no means least, political motivations influencing NHS demand as well as local authority contributions to care costs. We have already discussed the sensitivities relating to life expectancy. The same is true of inflation and the impact of higher than expected levels of future inflation can be seen in Table 3. ASHE th percentile Wage We have used a simple example of a PPO claim comprising an initial lump sum of GBP1.5m and anticipated annual payments of GBP150,000 for 40 years. We have then applied two inflation rates, one at 4 % and the other at 8 % per annum. The final cumulative payments by both insurer and reinsurer increase by more than 150 % under the second scenario. The impact is also shown in Graphs 2 and 3. Table3 Original Deductible GBP3m Inflation Rate 4 % 8 % Deductible 6,301,531 16,143,391 Recovery 9,452,296 24,215,087 FGU nominal value 15,753,827 40,358,478 Source: Gen Re (General Reinsurance AG, London Branch) We recognise that uncertainty over future inflation levels is somewhat mitigated by the likelihood that investment returns will be higher, but it does not remove the risk of an increased financial burden on both insurers and their reinsurers. Operation of the index clause As noted under the section entitled Impact on Excess of Loss, it is evident that high layers of excess of loss reinsurance programmes which were not previously affected are now exposed to PPO losses. The impact of inflation on PPOs is shared equally between insurance companies and their reinsurers. The operation of the index clause ensures that not only are the same number of claims ceded to reinsurance programmes, but also that the total value of the FGU claim is shared in the same proportion between insurers and their reinsurers, irrespective of the rate of inflation. This is contrary to the view expressed in the paper presented at the Actuarial Profession s GIRO conference in October 2010 that very few claims will reach the layer because of the operation of the index clause. 1 Let us take the same example as above, a PPO claim comprising an initial lump sum of GBP1.5m and anticipated annual payments of GBP150,000 for 40 years. Applying a similarly simple assumption of no inflation, that equates to a total claim at today s values of GBP7.5m. Over the 40 year settlement period, an insurer with a Treaty deductible of 43

45 GBP3m would therefore claim a GBP4.5m reinsurance recovery, equivalent to 60 % of the total claim. The index clause operates in such a way that 60 % will be the proportion of the total claim that the reinsurer will bear over the 40 year period, regardless of the actual inflation rate and movement in the deductible (and limit). If we apply a 4 % inflation rate to the above example, the claim will ultimately amount to GBP15.75m, Accumulated Payments No Inflation Graph 2 Quantum of Claim (GBP 000) 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 Source: Markit Group Limited Reinsurance Retention Year 4.5m (60 %) 3.0m (40 %) Accumulated Payments Inflation = 4 % Graph 3 Quantum of Claim (GBP 000) 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 Reinsurance Retention Year 9.45m (60 %) 6.3m (40 %) Investment Return Graph 4 Annual Yield / Claims Inflation ( %) ASHEC Corporate 25+ Overall A 3-5 Overall AA 3-5 GBP Gilts 3-5 but over time the insurer would still collect 60 % of that total value. Graphs 2 and 3 show the payment stream for the two scenarios, with the final allocation of the loss between insurer and reinsurer being the same. Graph 3 also highlights an obvious effect of the index clause on payout patterns in that the retention increases every year and hence the insurer continues to pay a share of the annual payments, even after the retention has been breached. However, it is important to reiterate that, irrespective of the rate of inflation, the deductible is first breached after 10 years and ultimately the reinsurer pays the same proportion (60 %) of the total value of the claim. Investment return Given the extended settlement period of claims under PPOs, the investment return earned by (re)insurers over this period is another key consideration. In particular, it is the relationship between (a) the future anticipated investment return and (b) the expected inflation rate that will be applied to the annual payments that is critical. Further, since the vast majority of annual settlements under PPOs relate to care costs, it is the care workers wage inflation rate with which we are concerned. We have looked at the relationship between these two variables over the past 10 years in Graph 4. The red line represents the ASHE Index 6115 at the 75th centile discussed earlier. This is compared with the annual yield of four different iboxx 2 benchmark indices, which we have used as proxies for the investment portfolios that different companies may hold. Graph 4 shows that in recent years, investment returns have comfortably exceeded the ASHE 6115 Index, as wage inflation has been depressed due to the uncertain economic conditions around the world. However, when looking at the period before 2005, the opposite is true. In that period, investment returns struggled to keep pace with the inflationary pressures on large BI claims, which were driven by a number of factors, including legislative reform and favourable economic conditions that led to high inflationary increases in care workers wages. We accept that companies may use different portfolios, with longer durations and lower average credit quality, which may deliver higher returns. However, such a strategy would also have to allow for the higher capital requirements that would be 44

46 needed to address the greater risk associated with such portfolios, particularly under the new Solvency II regime that will soon come into force. Further, insurers and reinsurers who seek to match the duration of their liabilities by investing in long-dated securities are unlikely to achieve a high rate of return in today s market and then face the risk of a secure investment return failing to match future inflation, which is likely to remain volatile. We believe that inflationary pressures on the UK economy will lead to higher wage inflation in the short-term and that the current phenomenon noted in Graph 4 is a temporary one. This will be particularly true of the care industry. As we noted earlier, in common with other developed countries, the UK is facing the prospect of an ageing population that will increase the demand for care workers. This trend will be accompanied by medical advances providing improved (and more expensive) care regimes for injured people. Given all the uncertainties surrounding the cost of PPOs discussed earlier in this article, we believe that (re) insurers should be adopting prudent assumptions in this area and allowing for the fact that claims inflation could continue to exceed investment returns for an extended period of time. Our current pricing assumptions assume a negative 1 % real rate of return, with claims inflation at 4 % and future investment returns at 3 %. Accounting treatment Before closing, we would also like to discuss briefly how we believe reserves in respect of PPO claims should be presented in financial statements. Under UK accounting rules, such reserves can be reported on a discounted basis, taking credit for the investment income to be earned over the settlement period. This accounting treatment is allowed under FSA Regulation GENPRU R, which allows claims payments under annuitytype arrangements to be discounted as long as certain conditions are met, including the requirement that the entity is not in run-off and that the average settlement period is more than four years. Prior to becoming a branch of General Reinsurance AG in late 2010, we were a FSA regulated entity and reported such reserves on a discounted basis in both our statutory accounts and regulatory returns. Further, our pricing assumptions also reflect the benefit gained from investment returns over the extended payment period of PPOs. Capitalisation clauses We are aware from a number of client discussions that there is an increasing desire to explore the viability of a compulsory capitalisation clause. Insurers see such clauses as a means of addressing the credit risk associated with the long duration of their reinsurance recoverable asset, while reinsurers gain certainty over their ultimate liability. We are happy to discuss these options with clients and will assess the merits of proposed wordings on a case-bycase basis. As long as both sides understand their respective positions and are willing to negotiate a structure that is equitable, then we see no reason why such clauses could not form an important and useful feature of reinsurance treaties. 1 Extracted from the paper by the GIRO Working Party 2010 entitled Periodic Payment Order. 2 iboxx is a consortium of seven investment banks. iboxx Ltd. was established to create and publish a new generation of fixed income prices and indices, based on selected multiple contributor pricing, transparency, third party quality control and accessibility. Summary As noted at the beginning of this article, we believe that the inherent uncertainty associated with PPO claims is much greater when compared to more traditional lump settlements. Insurers, as well as their reinsurance panel have to address the increased risks associated with crucial factors such as the life expectancy of claimants as well as long-term inflation rates and investment returns. The poor results reported by the motor market in recent years have rightly led to rate increases being applied to address increasing loss costs. The risks associated with PPOs will only add to the upward pressure on claims and it is clear to us that reinsurers will have to raise their prices in order to be paid adequately for assuming the increased volatility associated with such risks. 45

47 A Year After the Tohoku Earthquake Takashi Ishii Takashi Ishii is a General Manager of P&C Reinsurance Office in Tokyo, and is in charge of Japanese treaty business. He has over 30 years experience in the Japanese reinsurance market, and joined Gen Re in 2001 as a country manager. He studied Economics and Risk Management at his university, and has a deep knowledge of the Japanese insurance market. takashi.ishii@genre.com Tel

48 A year has passed since the Tohoku earthquake of 11 March The details of the disaster have all become clear. It is still terrifying to read the data. The Fukushima Daiichi Nuclear Power Plant is now under control, but the radiation issues remain unresolved. Everyone hopes to see the earliest removal of the radiated soil and other materials. The damaged reactors of the Fukushima Daiichi Nuclear Power Plant are now under cold shutdown, but the myth about the absolute safety of the nuclear power plant has been destroyed. Before the accident, a quarter of the electricity in Japan was produced by nuclear power. The shortage of this power supply is now a serious concern for people s daily lives and the country s industrial production. This article will discuss the major points of the economic loss of the Tohoku earthquake, as well as the specifics of risk financing, especially through insurance, and how Japan should prepare for future catastrophic events. The Tohoku earthquake was a once in a thousand years event, but it was not the largest possible economic earthquake event in Japan. The Central Disaster Prevention Council (CDPC) chaired by Japan s Prime Minister, conducts studies on the economic loss estimate for large earthquakes predicted to occur in the near future. Several of those calculations exceed JPY 16.9 trillion (USD 210 billion), which is the current estimate of direct economic loss from the Tohoku earthquake, as disclosed by the Cabinet Office on 24 June Magnitude levels of these earthquakes are below 9.0, but the population and economic value of the expected stricken area are larger than those of the Tohoku region. In addition, the combination of the distance from the epicenter, 47

49 soil, landscape, season, wind, fire occurrence and other factors may cause more serious economic loss. Moreover, we cannot escape from the beyond-expectation scale event, as we experienced during the Tohoku earthquake. Japanese islands are constantly threatened by super typhoons, such as Typhoon Isewan (Vera) of While this article concentrates on earthquake and tsunami, people residing in Japan should always be aware of and be prepared for the possibility of a large catastrophic event. In the Japanese economy, the ratio of insurance payment toward earthquake economic loss and the insurance penetration is relatively low. To protect ourselves from natural calamities, it is essential to establish effective systems of public administration safety engineering, disaster prevention, urban engineering, evacuation routes and destinations, hospitals, fire-fighting, medical services, infrastructure for water supply, gas and electricity, and so on. The implementation of a Business Continuity Plan (BCP) is important for industrial enterprises as well. A BCP provides for the safety of employees and their families and intends to educate them about how they should act during a catastrophic 48 event. It regulates communication with clients and vendors, specifies alternative solutions for production plant and/or office, procurement of (raw) materials, secures that a minimum number of staff is available, and concentrates resources to prioritized business activities. In order to continue business operations during a disaster, various additional expenses arise, including temporary arrangements for staff, procurement of raw materials and recovery. Therefore, companies need to provide for a risk finance plan and secure the necessary funds, or establish the method to raise such funds in advance. Individuals need money to buy food, transportation, gas, housing or repair work for living arrangements. Insurance can be an effective method to hedge these economic risks, but at the time of the Tohoku earthquake its penetration was not sufficient. Economic loss caused by the Tohoku earthquake The combination of the Tohoku earthquake and tsunami represents one of the largest natural catastrophes in history. The 9.0 magnitude is the highest in the history of Japan s meteorological record, and it is also considered the biggest within the last millennium. The highest point of the tsunami was recorded as 38.9m; it swept away many cities, towns and villages across a wide area on the Pacific coast. The number of fatalities (including deaths and missing people) is around 19,000, making it the worst disaster in Japan since World War II. The economic impact is significant. The Cabinet Office estimates its direct economic loss at JPY 16.9 trillion, excluding losses related to the Fukushima Daiichi Nuclear Power Plant accident. This amount exceeds the JPY 9.6 trillion loss from the Great Hanshin earthquake of 1995 and the USD 125 billion loss from Hurricane Katrina in Indirect losses will continue to increase for several years, even with production activities resuming. The overall economic loss will become much larger than the direct loss. The financial effect on major listed companies as of 30 September 2011 is estimated at more than JPY 3 trillion. 2 It includes indirect losses caused by the breakdown of supply chains, and the operation of corporations not only in the affected area but also in the greater Tokyo and other economic regions. In our globalized economy, the problem extends to companies all over the world. The Tohoku region is

50 of one of the largest regions that produce and supply cutting-edge products, such as semi-conductors, ultra-thin batteries, flash memory and car parts. Just-in-time delivery is global, and the suspension of supply for one or two weeks immediately affects the operation of various businesses. Thus, both Japanese and non-japanese manufacturers of Economic loss in the farming and fishing industry is also significant. Approximately 23,600 ha of land along the coastal area of Eastern Japan was swept away or flooded by tsunami water. 3 It might take several years to remove the debris and salt and change it back to arable land. Many fishing ports were destroyed and hundreds of boats and fishing The Tohoku earthquake was a once in a thousand years event, but not the largest... electronics, automotives and semiconductors were severely impacted by the earthquake. Companies moving to other regions or countries, along with local industries stopping operations or reducing their range of activities, have increased the unemployment rate. Further, under a special treatment by banks to postpone settlements, the actual extent of many companies debts has not yet fully surfaced. equipment lost. As the local agriculture and fishery businesses are primarily run by elderly people (two-thirds of farmers and one-third of fishermen are older than 65), many of them might not be motivated to restart their businesses. This is clearly the largest insurance loss event in Japan. From disclosures by insurance companies and major cooperatives as of March 2011, the total paid so far by Property and Casualty (P&C) insurance, Household insurance, Cooperatives and Life insurance is about JPY 3 trillion (USD 37.5 billion). P&C, including Household and Cooperatives, alone totaled around JPY 2.8 trillion (USD 35 billion). These amounts far exceed those of Typhoon Mireille in 1991 (JPY billion) and the Great Hanshin Earthquake (JPY 300 billion), the world s second largest insurance loss next to that of Hurricane Katrina. Since insurance companies bought reinsurance, around JPY 900 billion (i.e., about one-third of the P&C insurance loss payment) will be recovered from the reinsurance market. Perception of risk and risk hedge If an earthquake of the same magnitude as the ones shown in Table 1 were to occur again, economic loss would be larger than that caused by the Tohoku earthquake. The damage from a worst case scenario, where Tokyo is the epicenter of an earthquake, has been predicted by HERP 4 to occur with 70 % probability during the next 30 years and expected to exceed the damage of the Tohoku earthquake by four times. A Tokai earthquake is predicted to occur with 88 % probability during the next 30 years, and the worst case scenario predicts losses about 50 % higher than after the Tohoku earthquake. Destructive earthquakes on the Pacific coast from Kanto area to Western Japan since the 17th century Table 1 Kanto Tokai Tonankai Nankai Kanei M Keicho M Genroku M Tenmei M Hoei M Ansei Edo M Ansei Tokai M Ansei Nankai M Great Kanto M Showa Tonankai M Mikawa M Showa Nankai M years passed 2011 Ocean trench earthquake Epicentral earthquake 49

51 Based on the periodicity of large earthquakes, one would assume that there must have been earthquakes with a probable economic impact greater than that of the Tohoku earthquake during the last 400 years. On average, Japan experienced a destructive earthquake times every 100 years. It is also worth noting that several severe earthquakes occurred within a short period of time, for example, Genroku (1703) and Hoei (1707), three earthquakes (Tokai, Nankai and Edo) in the Ansei era ( ), and four continuous Showa earthquakes in the 1940s. The occurrence of a Tokai earthquake is of special concern; these major earthquakes on the Suruga trough occur at regular intervals of years, and 158 years have passed since the 1854 Ansei Tokai earthquake. Another important problem is that data on past earthquakes do not cover all earthquake events. Earthquake prediction is the result of linking fragmentary knowledge and data under various assumptions. This methodology is not perfect, and what we know today is only a part of the whole picture. Before the Tohoku earthquake, many seismologists were positive that no earthquake larger than the 1707 Hoei (M ) was likely to occur in Japan. The Tohoku earthquake unfortunately proved them wrong. Economic loss and insurance payment The Tohoku earthquake represents the greatest economic loss in Japan s history and the world s second largest insured loss at JPY 2.8 trillion (P&C). In relation to insurance penetration, however, the direct economic loss would account for about 15 %, which suggests that counting on insurance as a hedge for economic risk is not sufficient. Natural catastrophes and insurance payment Globally, in terms of premium volume, Japan is the second largest life insurance market, and the third largest P&C market. The ratio of insurance premium to the respective GDP figures, however, presents a different picture. Penetration of life insurance in the Japanese market is relatively high, whereas Japan s P&C insurance ratio is 2.1 %, i.e., lower than the world average of 2.9 %, and less than half of the U.S., South Korea and New Zealand, which is another earthquake country. The ratio is also significantly lower than in Germany, the United Kingdom, France and other developed countries. 5 The economic value located in Japan is one of the largest in the world, even though the country is threatened by such various natural perils as earthquake, tsunami, volcanic eruption, typhoon and heavy rain. Consequently, the reliance on P&C insurance should be higher than in other nations. The reality, however, is different. It is influenced by such factors as perception of risk, culture, speed of post-war economic growth, insurance coverage and premium level, strategy and the fact that solvency growth of insurance companies could not keep pace with the increase in accumulation risks. The 15 % ratio of the Tohoku earthquake insurance payment on economic loss is much lower than after the natural disasters in the U.S., Chile, New Zealand and other nations, where in many cases 30 % 60 % of the economic loss was covered by insurance. In Japan, more than half of the households do not buy earthquake insurance. As for industrial enterprises it is estimated that the 50

52 present coverage ratio of earthquake insurance among fire insurance policy holders is 20 % or less. It is even more difficult to find earthquake insurance for Business interruption (BI) and Contingent Business Interruption (CBI). Low insurance penetration means insufficient funds for enterprises to restart production activities, and any delay in the recovery process will result in a larger indirect loss and shortfall. Importance of improving risk finance by insurance After World War II, Japan experienced a quick economic recovery. Demand for insurance developed accordingly, and insurers responded by increasing their capital bases and buying reinsurance. Nevertheless, it was difficult for them to respond fully to the abrupt increase in accumulation risks, namely such natural perils as earthquake and wind/flood. In other words, insurers could manage increments of each and every risk of fire, automobile and others, but accumulation risks for earthquake, windstorm and flood grew much faster; capital increase, purchase of reinsurance capacity and other measures could not keep pace with it. Under these circumstances, insurance companies have cautiously adapted coverage conditions for earthquake, windstorm and flood. The business risk of a P&C insurance company is critical, and its management is required to prepare for a sudden reduction in equity caused by catastrophes or an economic crisis. Management also needs to consider rate and capacity fluctuations in the international reinsurance market. Once they increase their capital base, they need to pay the dividend for the additional capital, and it is not practical to increase the capital only for the catastrophe business. The management needs to be sure about the overall business profitability by expanding noncatastrophe business as well. Ironically, this cautious management strategy inhibited the promotion of earthquake insurance. Another important reason might be the culture. Japanese people tend to be convinced that they wouldn t encounter enormous and very inconvenient problems. After an insurance period with no accident, they feel relieved, concluding that the insurance premium was wasted. In addition, people are often conscious of what others do, and feel safe following the same behavior. If a neighbor or rival company does not buy insurance, there is no necessity for them to buy any. Despite the risk involved, this tendency seems particularly strong with regard to earthquake insurance. However, the establishment of effective Enterprise Risk Management (ERM), including risk finance, is becoming a key factor in order to be accepted as a competitive member in the international business world. Another problem for insurance companies is that the Tohoku earthquake far exceeded the model assumptions. A review of the whole risk evaluation process is essential for industrial earthquake insurance, as insurance companies need to secure the necessary capital and reinsurance on their own, while a large share of the household earthquake insurance is carried by the government. None of the data from the M9.0 and the massive tsunami have been entered in the present models, as the probability of a similar earthquake and tsunami is considered low. The present models are no longer appropriate for calculating reasonable insurance and reinsurance rates or considering adequate terms and conditions. In fact, when model companies estimated the loss soon after the event, it was substantially underestimated. The reliability of Cat models is crucial especially for reinsurance companies, who pay a large part of the loss in case of huge natural catastrophes. Natural catastrophes are increasing globally, causing reinsurance losses for unpredicted events. The big gap between model calculations and real exposure needs to be closed. The most important challenge is how an insurance company can secure additional reinsurance capacity while maintaining reasonable rates for their clients. It is difficult to promote industrial earthquake insurance if there is an adverse gap between the rates of primary insurance and reinsurance. However, after the Tohoku earthquake, risk finance is gaining importance, and the demand for earthquake insurance is growing. To respond to this demand, Japanese insurance companies must increase capital strength and secure larger reinsurance capacity by listening carefully to their reinsurers. 1 Higher estimates from private companies do exist, but for this article we chose to rely on official Japanese government statistics. 2 Tokyo Shoko Research, Ltd., 9 March Ministry of Agriculture, Forestry and Fishery, Statistics disclosed on 29 March HERP: Headquaters of Earthquake Research Promotion, A special institute of the Japanese government. 5 Swiss Re, Sigma 2011, No.2. 51

53 Offshore Wind Energy in Europe Fresh Wind for Insurers, Too? by Oliver Stein Renewable Energy Sources Development and Perspectives by Kathrin Haltenhof Insurers play a key role in the expansion of offshore wind energy. Without comprehensive insurance cover, investors would not be prepared to provide sufficient capital for such projects. This developing market offers significant business opportunities and premium volumes for insurance companies. However, they must first overcome a number of challenges. Technological development is progressing rapidly and there is still relatively little experience in assessing risks, but potential policyholders have very high expectations in respect of the extent of required cover. These challenges must be met if insurers are to be able to deal with the potential consequences of a storm developing from that fresh wind. The concept of harnessing the power of nature in the form of wind, water and solar power in order to supply the forecast, continuously growing demand for energy in particular in Asia (China) is not new. Renewable energies will, however, play an increasingly important role in the supply of power primarily because of the finite supply of fossil fuels, but also because renewables provide the key to sustainably achieving the various climate protection targets. This article highlights the development of wind and solar energy as important sources of power generation. Liability Insurance for Wind Energy Projects by Dmitry Danilin The diversity of the various wind energy projects, their underlying technology, the location of the site as well as the activities of the insured operator are the primary factors affecting potential liability claims. On the basis of these key parameters, underwriters can analyse further specifics of an individual risk. This article discusses the challenges liability insurers face in connection with these risks. 52

54 Periodic Payment Orders in the UK A Reinsurer s View by Mike O Dea, Ines Hellmayr and Geoff Piggot The European Battle Over Sex Human Beings Are Above Statistics by Andres Webersinke Periodic Payment Orders (PPOs) have become an increasingly common occurrence in the settlement of higher value bodily injury (BI) claims in recent years, particularly those with a value in excess of GBP1m. Under PPOs, claims are settled by way of an initial lump sum amount to ensure that the claimant is able to adjust to the new circumstances and lifestyle, together with an agreed annual payment, usually to cover future care costs. The article discusses the key considerations frequency of PPOs, impact of mortality and inflation on claims costs to the reinsured and reinsurer, operation of the index clause in reinsurance treaties and greater importance and sensitivity associated with investment returns. Gender as a factor in calculating insurance premiums and benefits is widely used and well established. Its use, however, will be banned in the European Union by the end of This article discusses the background of this change and the impact it has on the industry, in particular to life insurance. Yonder Lies the Way or How to Manage Process Risk in Insurance Sales by Astrid Kahl Process optimisation or enhancement is a topic that direct insurers increasingly have to navigate to combat the rising cost pressure and improve their services. All areas are to be analysed and opportunities sought to streamline and speed up processes, and thus meet the growing expectations of the customers. A Year After the Tohoku Earthquake by Takashi Ishii The M 9.0 Tohoku earthquake occurred off the coast of Northern Japan on 11 March 2011, triggering a massive tsunami that inundated a huge area along the Pacific coast. The Tohoku earthquake is an unprecedented event, but this does not necessarily mean that it was the largest possible economic earthquake event in Japan. The demand for earthquake insurance is increasing, but the reliability of Cat modeling is crucial. To respond to this demand, insurance companies must increase capital strength and secure larger reinsurance capacity. 53