Germany's strong and powerful professional reinsurers have not been watching from the sidelines while their home market goes ex-growth, comments Lee Coppack after a trip to visit them.

With strategic alliances largely in place, the six largest reinsurers are now giving clear indications of the way business is likely to develop: an increase of activities in non-catastrophe classes and growing, long term lines, added services to ceding companies, the development of new activities which are natural extensions of their existing businesses, such as alternative risk finance products, and an expansion of their already extensive international presence into growing markets.

Deregulation of direct insurance in Germany in 1994 did not bring a flood of foreign competitors into the market; instead it spurred intense competition among domestic insurers but the predicted losses have not materialised. The result has been:

* The total number of German non-life insurance companies has been falling sharply. Having reached 358 in 1992, the number had dropped to 281 by the end of 1995 and 266 in 1996.1 Some of this fall is due to the conversion of subsidiaries of insurers from other EU countries into branches under the single passport arrangements, but Werner Mutz, director in charge of Germany for Gerling Globale, predicts a further contraction of as much as one-third in the total number of insurers over the next five years.

* Private motor insurance, by far the largest non-life class of business, has dropped from gross premiums of DM 44.1 billion at its peak in 1995 to an estimated DM 40.6 billion in 1997, a reduction over two years of 8%. Meanwhile, the number of vehicles has continued to rise: from 40.4 million private cars in 1995 to 41.4 million in 1997.

* Industrial fire, historically a competitive class, has fallen from a peak of DM 7.0 billion in 1994 to an estimated DM 6.0 billion last year.

* Insurance companies are larger and wealthier, for the same reasons as elsewhere. As a result, they retain more risk and shift their reinsurance purchases to higher level excess of loss. The capital of property/casualty insurers rose from DM 129.5 billion in 1995 to DM 144.7 billion in 1995 and DM 158.5 billion in 1996 and will be higher still in 1997 thanks to good results now being announced. Growth between 1995 and 1996 was 9.5%.

Exactly how much reinsurance business is available in the German market is difficult to calculate, because there is likely to be a material element of double counting thanks to the close links between a number of the professional reinsurers and direct insurers. However, table 1 gives an indication.

Out of approximately DM 36 billion total German reinsurance premiums written by German professional reinsurers in 1996, Munich Re was the largest with DM 8.6 billion gross. The next largest players as a group are Bavarian Re, Cologne Re, ERC Frankona, Gerling Globale and Hannover Re which also owns a majority holding in Eisen und Stahl Re, itself a significant reinsurer.

The likelihood of mergers or acquisitions among the major reinsurers is not high. Five of them have major alliances, either by parent or by subsidiary, which would make them largely indigestible to a takeover by another reinsurer. If there is a structural change in the near term, it is likely to involve Gerling Globale, which is 30% owned by Deutsche Bank and 70% by the Gerling family through the Gerling Group.

This spring the bank indicated it was uncomfortable with its current level of holding in Gerling and would prefer either "all or nothing," according to a report from Reuters. The prospect of a takeover would not alarm Gerling Globale. "I would consider Deutsche Bank a safe harbour," says Klaus Bultmann, a member of the reinsurance company board.


However imprecise the estimate of total reinsurance volume, it is clear that the amount of business of Germany's professional reinsurers coming from Germany is not growing and, if anything, the trend since then will have been downward in real terms thanks to weaker original rates, increased retentions and increasing use of non-proportional treaties.

Dr Ludger Arnoldussen, deputy member of the board of management at Bavarian Re says: "Primary companies have increased their funds so some of them feel they can run more risk on their own, particularly in proportional."

The most dramatic evidence so far of the shift toward excess of loss came in November when the recently rechristened AXA Colonia announced that from 1998 it would save over DM 270 million a year by substituting excess of loss cover for proportional treaties in a number of classes, including industrial fire. A similar but more gradual shift is taking place in the company's reinsurance programme for private lines. Generali may look similarly on the mixed programme of reinsurances of its new German subsidiary AMB when they come up for renewal. The effect of these changes on total reinsurance premiums will only emerge into the 1998 figures and beyond.

A major part of Munich Re's approach has been to strengthen its longstanding activities in profitable direct personal lines in the German market. By the deft stroke of merging the insurance groups Hamburg-Mannheimer, in which it already had an 80% share; the health insurance company DKV, in which it had a 60% stake and VICTORIA and its legal expenses subsidiary D.A.S. in which it had a 24% holding directly and indirectly, Munich Re has been able to add approximately DM 8.4 billion to its consolidated premium income without spending any money. As a result of its holding in the combined group, called ERGO, the group's premium income will now be approximately equally balanced between direct and reinsurance. The move was well received by analysts.

Munich Re spokesman Rainer Küppers explains that ERGO writes mainly personal lines and only some commercial business. "Reinsurance is normally quite volatile. This is steady, stable business to balance the group results."

It does mean that Munich Re is competing indirectly with some of its clients, but Herr Küppers points out that the group has long had a substantial presence in the German direct market and he draws a distinction between the activities of the reinsurance company and other parts of the group. "Our subsidiaries were always in competition with other direct insurers. Nothing has really changed. What is new is that we have bundled the companies together under the management of a holding company to make them more efficient. This holding company has been interposed between our insurance subsidiaries and the reinsurer, so in fact there is more separation than in the past."

At Cologne Re, the chairman of the executive board, Dr Peter Lütke-Bornefeld, is committed to the principle that his company's relationship is with the ceding company, even to the extent of not directly cultivating relationships with major insurance buyers as is a regular comment from other reinsurers. Nor would it write primary business.

Pursuing its philosophy of client intimacy, Cologne Re has strengthened its position in the reinsurance market for mutual insurance companies, still an important force on the continent, through the acquisition of a 27% stake in Cologne based Gothaer Re, which is well established in that sector. "We are looking to stabilise and even enhance our relationship with that group," says Dr Lütke-Bornefeld.

Dr Lütke-Bornefeld believes that while there will be a shift toward non-proportional business from German clients, it will not necessarily make reinsurers' results more volatile, especially from catastrophe business, since most German ceding companies already protect their retentions in this way. "It should not be a problem as long as it is adequately rated. It is our business," he says.

Looking forward, he explains that Cologne Re looks to keep a balance between technical underwriting, consistent profitability and defence of its portfolio. "It is through client relationships that we will go for further growth."

Hannover Re is different in that it is 75% owned by the industrial insurance mutual HDI and has close links with other industrial mutuals through its majority shareholding in Eisen & Stahl Re. The bulk of its German business comes from its shareholders and it says in its most recent newsletter: "Both in terms of the original terms and conditions and the reinsurance conditions, the quality of this business is considerably higher than the market average." As a result, Hannover Re will be affected less than average by this development and expects its 1998 profit objectives to be "scarcely affected".

ERC Frankona in Germany was, ceo Bernhard Fink admits, preoccupied in 1996 with corporate changes following its takover by ERC, but it has regrouped its forces and begun gaining new business. It has set up a business development unit to look at new opportunities including acquisitions, joint ventures and start up operations. "We want to be seen as different from our peers in being more entrepreneurial," he explains. Being part of GE Capital, which ranks number 17 on the Fortune 500 list with its $40 billion a year in revenue, cannot hurt in this respect, and Herr Fink says GE Capital plans to exploit its own brand increasingly.

Another tactic is the careful selection of particular market segments. ERC Frankona has adopted this approach, for example, in relation to its aviation reinsurance book. Some classes of business may be under-developed even in sophisticated markets, for example, health reinsurance about which Herr Fink says: "In the health area there is little conventional reinsurance in continental markets." ERC Frankona has been particularly successful in developing its book in the UK and in France where Herr Fink believes that it has even overtaken SCOR.

Life and health classes are particularly attractive because they are stable, non-catastrophic lines which are growing, even in developed markets, as a result of social and demographic change. Professional reinsurers also feel they can add value through their technical expertise. Making a preliminary announcement of its 1997 results last month Cologne Re stated that an increase of approximately 12% in gross premiums to around DM 7 billion was primarily attributable to a 30% rise in life and health business. "This facilitated a further increase in the stabilising share of the life portfolio in our overall business. Worldwide life and health business is one of Cologne Re's strategic growth areas and we have already established ourselves in this market as one of the world's leading providers of technical expertise in life underwriting."

Dr Tauno Jäkel, senior account executive for European life and health at Bavarian Re, confirms that the general trend toward a reduction in state provision of benefits is leaving the private sector to make up the shortfall and his company is looking to introduce new products, particularly in health insurance, to support primary insurers in developing these areas.

As a member of the Swiss Re group, Bavarian Re concentrates on European markets and gets over half its premium volume from Germany. It enjoys great client loyalty; in April, Standard & Poor's remarked on a retention rate of nearly 100%.

One way of doing that is for the reinsurer to offer services and expertise, from which primary insurers can benefit, especially to smaller and medium sized companies, and which they can also offer to their clients, reinforcing the chain of loyalty. Dr Jäkel, for example, mentions a claims management service for accident victims, which Bavarian Re started about two years ago. Even though the reinsurer is one step removed from the victim, he says: "We can approach all the parties concerned and make the connections between them to help get the person back to work quickly." Cologne Re has developed a similar facility.

With a flat home market, further expansion abroad is attractive. As Gerling Globale's Herr Bultmann remarks: "It is difficult for German reinsurance companies to grow just by improving their situation." Gerling, he says, would like to make acquisitions to expand, particularly in the United States where he feels the company's position as number 27 in the market does not give it sufficient mass. The company has also just opened an office in Tokyo.

Financial engineering

Not surprisingly, all Germany's leading reinsurers are interested in the development of alternative risk transfer (ART) mechanisms or financial engineering to use a more descriptive phrase. Hannover Re has chosen high visibility as part of its marketing strategy. Having already been involved in property risk deals, in April the company arranged a securitised life reinsurance transaction with Rabobank in Dublin effectively to retrocede up to DM 100 million acquisition costs from its rapidly expanding life reinsurance business.

Gerling set up a separate company, Gerling-Global Financial Products in February 1997, to expand its business in finite risk and financial products. In its first year, the company closed several key deals including a loss portfolio transfer for a large health care provider, a combination of stop loss and quota share protection needed by an insurance group to facilitate the sale of a subsidiary and a multi-year, profit sharing property catastrophe programme for an insurance company.

At ERC Frankona, Dr Karl Mayr, a member of the board of management, says he sees as much potential profit - as opposed to premium volume - coming from ART products as from quota share or excess of loss over the next 10 years. ERC Frankona has set up a division to develop tailor made deals and dovetail with the activities of its parent company ERC in the United States. "I cannot say exactly what proportion of our profits will come from ART but it will be very material. At the moment it is taking considerable time and resources." However, adds Dr Mayr, customers will also still expect traditional reinsurance with added value services, he says, which reinsurers will need to maintain or risk weakening their competitive position.

Asset management is an area in which reinsurers may become more active, as Swiss Re has demonstrated with its agreement in April to buy Falcon Asset Management from USF&G, newly merged into St Paul Companies as part its strategic development. Recently, Munich Re's chairman Hans-Jürgen Schinzler indicated the company is considering setting up its own asset management company for ERGO. Manfred Seitz, the group's executive manager for financial reinsurance and retrocession, explains that the company has for 11 years had a joint venture company with Mercury Asset Management, called Munich London Management Ltd, which assists national insurance companies in investing in foreign markets.

Lee Coppack is co-editor of Global Reinsurance. E-mail:

1. All figures from the Gesamtverband de Deutsche Versicherungswirtschaft (GDV).

Global Reinsurance co-editor Lee Coppack put some questions about the legal implications

of changes in the German market to lawyer, Dieter Lüer.

LC: What will be the main legal/regulatory issues arising if the frequently predicted restructuring of the German primary market takes place.

DL: 1. One area recently identified as being in need of an overhaul is that of insurance contract law, which is still governed by the Insurance Contract Act of 1908. This might appear rather surprising, but many of the changes that have occurred on the regulatory side have not yet been mirrored in the law of contracts. Consumers and lawyers complain of lack of certainty and transparency in insurance contracts, added to which there is political pressure, especially where the life insurance sector is concerned.

To try to introduce fundamental changes in the way that life insurance companies' capital gains are distributed to insureds, some supporters of reforms have presented a new legal definition of insurance premiums, splitting them into totally separate elements, such as a risk component, a savings component and charges for expenses and profits.

2. Another area beset with problems associated with the expected consolidation of German insurance companies is that of company law and public regulation of the insurance industry. Constantly reducing growth rates in the long term and the expected reversal of insurers' overall results are the current features pushing the industry in the direction of consolidation.

To push ahead with the consolidation process will require considerable imagination and all the skills that businessmen and their legal advisers can muster in order to find unconventional ways of establishing and defining rules of co-operation between companies that are difficult to merge, for separating and transferring parts of companies which would fit into a new entity or any other forms or combinations of methods for restructuring insurance companies which are exposed to the risk of failure. Similarly, the challenge for the authorities is not only to deal with possible casualties of the process but to assist with restructuring, insofar as this falls within their area of competence.

There has already been some experience of restructuring companies but will that be enough to overcome successfully all the problems which are to be expected? The authorities are certainly alert to early indications of companies finding themselves in difficulties, but it may be more difficult than in the past to find appropriate solutions.

LC: How well do you feel that state insurance regulators can oversee the solvency of the activities of their domestic insurance companies which write business in other, perhaps significantly different European markets?

DL: Experience shows that writing insurance business abroad involves major risks in cases where insurers do not do enough to prepare for such activity and do not have qualified management and controlling capacity available. Deregulation has also increased risks for those participating in markets they are not familiar with.

In the past, even insurance regulators exercising strict control over the companies in their home country were unable to prevent insurers from getting involved in disastrous activities in foreign markets. EU regulations have not improved this state of affairs by introducing solvency control of business underwritten on markets in other EU countries. My feeling is that despite some progress, there is still some way to go before uniform standards apply to insurance regulation in Europe and the necessary exchange of information between the national offices reduces existing risks.

LC: How do you feel relationships are changing between increasingly large German direct insurers and their reinsurers? Are they likely to become more contentious?

DL: Generally speaking, co-operation between German ceding companies and their reinsurers is based on reciprocal long term perspectives and mutual trust and still follows patterns based on the way in which the world's leading reinsurers handled business in their home markets. Operating against a background of strong commercial links, they tried to convince rather than compel and to negotiate rather than litigate.

Size was a less important factor in their relationship with both cedants and reinsurers.

Nevertheless, a number of factors which in the past were of minor importance will exert considerable influence in the future in the German market:

* reduction in the number of ceding companies

* declining volume of cessions

* change in the produce mix of business

* increased volatility of results from reinsurance cessions

* increased competition between financially stronger reinsurers

* fewer reinsurers present on the market - particularly from abroad - than in the past

* increased specialisation in reinsurance products (for example, catastrophe, alternative risk transfer or ART products)

* in the long run, much greater influence by investors on the way reinsurance is handled.

The way reinsurance is used must change as insurance companies start to work on the basis of more precise and explicit entrepreneurial targets and as the shareholder value concept influences more and more details and leads to short term thinking within management. Instead of balancing results over the years, it will become more important to gain short term advantages.

If all these factors are combined - even taking into account that they will work differently in each case - it means that the potential for conflict will most probably increase. The content of insurance contracts - their commercial objectives and the wordings used to achieve them - will undoubtedly gain in importance. This is only too obvious with financial reinsurance and ART contracts.

But the increased potential for conflict need not translate immediately into a growing number of conflicts or into arbitration cases or litigation. It is unrealistic to predict that Germany's reinsurance market will become as contentious a place as the United States or the London market in recent years.

However, German insurers and reinsurers alike ought to face up to the growing potential for conflict and ask themselves whether they are prepared to handle the foreseeable future adversarial nature of their businesses. If the assumption is correct that there is, generally speaking a less developed culture for handling serious conflicts, then litigation or compromise arrangements could become expensive consequences.

Dieter Lüer is a partner in the Munich law firm of Heuking Kühn Lüer Heussen Wojtek. He is a former director of Frankona Reinsurance. Tel: (49) 89-29-09-70; fax: (49) 89-29-09-72-00; e-mail: heuking_kuehn_muenchen@