Nature of risks associated with insurance contracts and financial instruments

Management of technical risks in property/casualty insurance

Insurance risks in non-life business (primary insurance and reinsurance) derive primarily from the premium/loss risk and the reserving risk.

Insurance business is based upon the assumption of individual risks from policyholders (in primary insurance) or cedants (in reinsurance) and the equalization of these risks in the community of (re)insureds and over time. For the insurer, the fundamental risk lies in providing insurance benefits, the amount and due date of which are unknown, from premiums calculated in advance that cannot be changed. The reserving risk arises out of the potentially insufficient establishment of reserves in the balance sheet and the resulting strain on the technical result.

We counter the assumed premium/loss risk inter alia through appropriate reinsurance protection. The volume of reinsurance protection relative to the gross written premium can be measured according to the level of retained premium; shown below broken down by segments, this indicates the proportion of written risks retained for our risk.

Retention by segments

2010

2009

%

   

Industrial Lines

46.1

43.7

Retail Germany

91.6

85.6

Retail International

92.4

86.9

Non-Life Reinsurance

88.9

94.1

Total Non-Life Insurance

78.9

78.7

The level of retained premium on the Group level in non-life insurance remained roughly on a par with the previous year at 78.9%, compared to 78.7%. Changes occurred on the level of individual segments, however, which in some cases were significant. Most notably, the cancellation of a quota share reinsurance treaty in the motor lines at the Turkish company HDI Sigorta – a move prompted by regulatory requirements – caused the retention to increase in the Retail International segment. The rise of retention in the Retail Germany segment can be attributed above all to the contraction in gross written premium. The reduced retention in Non-Life Reinsurance – which saw a drop from 94.1% to 88.9% – was due in large measure to the growth in gross premium volume, which increased by 10.3%.

The net loss ratio in the segments after Group restructuring developed as follows in a year-on-year comparison:

Net loss ratio by segments

2010

2009

%

   

Industrial Lines

82.0

68.6

Retail Germany

69.4

62.5

Retail International

75.6

71.6

Non-Life Reinsurance

72.0

72.8

Total Non-Life Insurance

73.6

70.5

The moderate level of the loss ratios in past years reflects our prudent underwriting policy and successes in active claims management. On the level of the Talanx Group the loss ratio for the non-life insurers climbed by altogether 3.1 percentage points in the year under review. The sharply higher loss ratio in the Industrial Lines segment can be attributed to increased strains associated in particular with major loss events. The loss ratio in the previous year had been driven by a generally favorable claims experience. The rise in the Retail Germany segment was due to motor insurance business in the year under review as well as the favorable claims experience in 2009. In the Retail International segment flooding and frost damage in Poland as well as well as earthquakes in Chile caused the loss ratio to surge sharply higher. In the Non-Life Reinsurance segment the loss ratio remained slightly below the level of the previous year – despite the burden of major losses (increase in catastrophe loss ratio from 4.6% in the previous year to 12.3% in the year under review) – thanks to a favorable run-off of claims incurred in prior years as well as a pleasing basic loss trend.

In order to ensure that the existing benefit commitments can be fulfilled at all times, corresponding provisions are established and their adequacy is continuously analyzed using actuarial methods. These also provide insights into the quality of the written risks, their spread across individual lines with differing risk exposures as well as the anticipated future claims payments. In addition, our portfolios are subject to active claims management. Analyses of the distribution of loss amounts and claim frequencies facilitate systematic management of the risks.

The loss reserves calculated in the reinsurance sector using actuarial methods are supplemented where necessary by additional reserves based on our own actuarial loss estimations and the IBNR (incurred but not reported) reserve for losses that have already occurred but have not yet been reported to us. Especially in casualty business, IBNR reserves – differentiated by risk classes and regions – are constituted in view of the long run-off of such claims.

The adequate measurement of loss reserves for asbestos-related claims and pollution damage is a highly complex matter, since in some cases several years or even decades may elapse between the causation of the loss or injury and its notification. The Group’s exposure to asbestos-related claims and pollution damage is, however, relatively slight. The adequacy of these reserves is normally measured using the so-called “survival ratio”. This ratio expresses how many years the reserves would cover if the average level of paid claims over the past three years were to continue. At the end of the year under review our survival ratio in the reinsurance sector stood at 22.8 (24.3) years; the reserves for asbestos-related claims and pollution damage amounted to EUR 212 (198) million.

Licensed scientific simulation models, supplemented by the expertise of the relevant specialist departments, are used to assess the material catastrophe risks from natural hazards (earthquake, windstorm) for the Non-Life Reinsurance segment. Furthermore, we establish the risk to our portfolio from various scenarios (e.g. hurricanes in the US, windstorms in Europe, earthquakes in the US) in the form of probability distributions. The monitoring of the natural hazards exposure of the portfolio (accumulation control) is rounded out by the progressive inclusion of realistic extreme loss scenarios.

We analyze extreme scenarios and accumulations that could lead to large losses. Based on the current and most recently calculated figures, the potential net loss burdens for the Group are as follows:

Accumulation scenarios 1)

2010

2009

Figures in EUR million

   

250-year loss US windstorm

709

763

250-year loss California earthquake

531

504

250-year loss European windstorm

530

581

250-year loss Tokyo earthquake

460

426

250-year loss Japanese windstorm

386

369

250-year loss Sydney earthquake

183

325


1) The actual natural catastrophe experiences may diverge from the model assumptions

Peak exposures from accumulation risks are protected against through the use of carefully and individually selected reinsurance covers. In this way we are able to effectively limit – and hence render plannable – large individual losses and the impact of accumulation events.

Run-off triangles are another tool used to verify our assumptions within the Group. Such triangles show the changes over time in the reserves as a consequence of paid claims and in the recalculation of the reserves that are to be established as at each balance sheet date. Adequacy is monitored using actuarial methods (see here also our explanatory remarks on the balance sheet item 20 “Loss and loss adjustment expense reserve”).

In property/casualty insurance the reserving risk is monitored and managed through analysis of the loss reserves using actuarial methods. In the case of the annuity reserve – as part of the loss and loss adjustment expense reserve – we also monitor the interest rate trend. A fall in interest rates would result in a charge to income owing to establishment of a reserve. The annuity reserve is calculated using the latest annuity tables as an actuarial basis.

An increase of 5 percentage points in the net loss ratio in the area of property/casualty insurance and non-life reinsurance would reduce the net profit after tax by EUR 321 (298) million.