Munich Re

ECONOMIC RISK CAPITAL

November 2011 Tony Green FSA, CERA, MAAA

Agenda

Enterprise Risk Management

q Risk Strategy

q Risk modeling

Credit risk

Insurance (aka Biometric) risk

Pandemic risk

Market risk

Operational risk

q Risk Results & Opportunities

2010 ERC Results

Risk & Solvency Consulting

2
 Munich Re

RISK STRATEGY

Munich Re's Risk Strategy

Category
Category Risk
Risk criteria
criteria Measure
Measure Criteria's
Criteria's objective
objective ERM
ERM objective
objective
addressed
addressed
Whole
Whole Financial
Financial strength
strength ERC
ERC Safeguarding
Safeguarding sufficient
sufficient
portfolio
portfolio Rating
Rating excess
excess capital
capital and
and limiting
limiting
Solvency frequency Maintaining
Maintaining Munich
Munich
criteria Solvency frequency of
of negative
negative
criteria economic Re's
Re's financial
financial
economic results
results of
of
Avoiding strength,
strength, thereby
thereby
Avoiding financial
financial distress
distress Negative
Negative economic
economic Munich
Munich Re's
Re's entire
entire risk
risk
earnings ensuring
ensuring thatthat all
all
earnings tolerated
tolerated portfolio
portfolio
every liabilities
liabilities to
to our
our
every 10
10 years
years
clients
clients can
can bebe met
met
Supple-
Supple- Peak
Peak risk
risk management
management VaR
VaR limits
limits as
as % % of
of Limiting
Limiting losses
losses from
from
mentary
mentary Individual Longevity AFR
AFR or
or limit
limit for
for individual
individual risks
risks or
or
maximum accumulation Protecting
Protecting and
and
criteria nat cat perils Financial maximum accumulation exposure
exposure
criteria exposure and increasing
increasing the
the
Terrorism sector limit exposure and liquidity
liquidity risks
risks that
that
could value
value of
of our
our
Pandemic could endanger
endanger Munich
Munich
Re's survival capability shareholders'
shareholders'
Re's survival capability
ALM
ALM limits
limits investment
investment
Liquidity
Liquidity

Other
Other E.g.,
E.g., Counterparty-credit
Counterparty-credit risk
risk Individual
Individual risk
risk Limiting
Limiting risks
risks that
that could
could Safeguarding
Safeguarding
criteria
criteria Single
Single risks
risks limits
limits in
in absolute
absolute sustainably
sustainably damage
damage thethe Munich
Munich Re's
Re's
Alternative value
value trust
trust of stakeholders in
of stakeholders in reputation,
reputation, thus
thus
Alternative investments
investments
Munich
Munich Re Re perpetuating
perpetuating future
future
Non-investment-grade
Non-investment-grade business
business potential
potential
investments
investments

44
 Munich Re

RISK MODELING

Quantitative Risk Modelling

- core element of ERM at Munich Re

Risk strategy
Set explicit limits
Clear internal and external signalling effect
Define framework for operative activities

Risk identification and

Risk identification early warnings
& early warnings Necessity of a
Risk steering panoramic vision
with focus on
Risk triggers, limits and core areas
measures facilitate ERM-
accountable
management action cycle Risk modelling
Central, competitive advantage
balancing flexibility and stability
Risk
modelling
Comprehensive risk governance Risk adequate incentives
and effective risk management and sustainable responsibility
functions

Risk management culture as a solid foundation

6
 Munich Re

Quantitative Risk Modelling

- based on Economic Balance Sheet concept

Valuation principles Economic balance sheet

From
From an
an economic
economic view,
view, the
the following
following
valuation Economic
valuation principles
principles prevail:
prevail:
Available Equity
Financial
Assets
Assets are
are valued
valued at
at their
their observable
observable Resources Economic
market (AFR) Risk
market values.
values.
Capital
Liabilities
Liabilities are
are valued
valued with
with techniques
techniques that
that Market
Assets at market
are
are consistent
consistent withwith financial
financial valuation
valuation Value
values
Margin
principles,
principles, e.g.,
e.g., options
options and
and guarantees
guarantees in in
primary Market
primary life
life business
business areare valued
valued with
with risk-
risk-
consistent value
neutral
neutral valuation
valuation techniques.
techniques. of liabilities Best
estimate
liabilities

The choice of the valuation principle is crucial for the risk measure

Economic Risk Capital (ERC) =175% VaR(99.5%)

Definition Distribution of Financial Position

Probability
Events that lead to a deviation of MCEV
of outcome
From the expected value
Over a one year horizon
99.5th percentile = Solvency II Standard
Munich Re targets 175% of VaR(99.5%)
Sufficient to maintain AA rating or VaR(99.97%)

Financial Expected Value

Financial Resources at
Resources at time t+1 KBBB (VAR 99.50%)
time t Capital required
KAAA (VAR 99.99%) for desired rating

8
 Munich Re

All risks are separately analysed and aggregated

using the underlying risk drivers

RISK

P&C large
Credit P&C basic Risk Life & Health Market Operational
losses
Corporate
Corporate Premium
Premium risk
risk NatCat
NatCat Mortality
Mortality Equities
Equities Fraud
Fraud
bonds
bonds Reserve
Reserve risk
risk Terror
Terror Lapse
Lapse Real
Real estate
estate Business
Business
Retro
Retro Further
Further large
large Incidence
Incidence Interest
Interest rates
rates interruption
interruption
receivables
receivables losses
losses Recovery Exchange Reporting
Reporting
Recovery Exchange rates
rates
Deposit
Deposit Dis. Implied IT
IT risks
risks
Dis. Mortality
Mortality Implied
receivables
receivables volatilities Legal
Calamity
Calamity volatilities Legal risks
risks

Individual modelling of all risk drivers

Credit risk portfolio models

Credit risk models quantify credit risks under consideration of portfolio effects:

Default models: Losses due to defaults are analysed.

Mark-to-Market models: in addition losses due to changes in market values of

instruments are taken into account.

Munich Re uses economic CreditMetrics approach (Mark-to-Market model) implemented in

the CreditManager software. Three main components:
Change of credit quality of a counterparty over the horizon of the analysis
(MRCM: 1 year) Ratings with respective transition probabilities
Change of market value of an instrument taking into account possible changes in the
credit quality of the issuer Credit Spreads, Recovery Rates
Dependency of changes in credit quality of several issuers
Correlations

10
 Munich Re

Credit risk modelling Exposures from investments and

other receivables considered

Market value and Market value Probability

rating at the today
beginning of the
one-year
simulation horizon A

Simulated credit
quality in one
year calibrated AAA AA A BBB BB B CCC Default
using transistion Portfolio value
probabilities
0.04% 2.17% 91.49% 5.62% 0.41% 0.17% 0.03% 0.053%
Aggregated
Aggregated value
value distribution
distribution in
in one
one
year
year
Revaluation using Typically skewed distribution for credit
Typically skewed distribution for credit
respective credit risk
risk
spread curves Multitude
Multitude ofof standard
standard analysis
analysis available
available
within
within the
the CreditManager
CreditManager
Market value at
the end of the MVAAA MVAA MVA MVBBB MVBB MVB MVCCC Recovery
simulation
horizon

11

The Mortality Risk Driver is built up from four components

Process Trend Basis Calamity Total

Process
Process risk:
risk: Trend
Trend risk:
risk: Basis
Basis risk:
risk: Calamity
Calamity risk:
risk: Aggregation:
Aggregation:
(Additive
(Additive Model)
Model)
random
random long-term
long-term trends
trends Future
Future vs.
vs. experience
experience infrequent,
infrequent, assumed
assumed independence
independence of
of risk
risk
fluctuation
fluctuation used
used to
to develop
develop catastrophic
catastrophic loss
loss components
components
assumptions
assumptions events
events

Volatility
Misestimation
+ Catastrophe
= Mortality Risk
12
 Munich Re

Other Risk Drivers follow a similar approach Built

from a basket of up to 4 Risk Components

Risk Drivers
Active Life Disabled Life
Mortality Lapse Incidence Recovery Dis Mort

Process Basis Trend Calamity

Risk Components

13

The Pandemic Model

External Calibration Munich Re produces an event set of about

4,000 pandemic scenarios representing both
Historic S-I-R influenza (flu) and Emerging Infectious
Data Simulation
Diseases (EIDs).

Unique events are further defined by other

important factors such as demographic
impacts, national countermeasures and
underwriting quality.
Event Set

Infectiousness and Lethality Likelihoods are assigned to each event

through a commonly used approach called a
Demographic Impacts susceptible, infected, and recovered (S-I-R)
model which calibrates the Event Set
National Countermeasures against historical data.

Baseline Mortality Adjustment The flexible model structure allows for

sensitivity analysis across the event set.

14
 Munich Re

Lethality and Infectiousness

- the defining characteristics of a Pandemic outbreak

The lethality of a pandemic is measured by the Deaths per Case (DpC) the number
of deaths given infection. DpC is typically calibrated to a Weibull distribution.
Infectiousness (R0) is the average number of people who are infected by an
infected individual and are best fit with a Lognormal distribution.
Combining the DpC and R0 reproduces historic pandemic events, i.e. the 1918
Spanish Influenza had (DpC, R0) of (2.5%, 2.25).
Lethality Infectiousness
1 1
H5N1
0.9 0.9
Seasonal
0.8 0.8 Flu 1968
1968
0.7 0.7
Probability

Probability
0.6 0.6
1957 1957
0.5 0.5
0.4 0.4
1918
0.3 0.3
1918
0.2 0.2
0.1 0.1
0 1708? 0
0 5 10 15 20 25 30 35 0 2 4 6 8
DpC (%) H5N1
R0
15

Portfolio Overview
Results of Pandemic model are incorporated into the
current Economic Risk Capital (ERC) Framework
The models derive a total
excess mortality - Exceedence
Probability curve for each major
business unit.

In order to compute required

capital, the tail of the
Exceedence Probability curve is
fit to a Pareto distribution.

The nature of the Munich Re ERC model incorporates the pandemic model directly
for each business unit and product line.
This flexibility allows detailed analysis of total pandemic risk at a the group level, and
for each new deal.

16
 Munich Re

Market risks
- analyzed in Algorithmics based on Replicating Portfolios
Group-wide
Group-wide consistent
consistent measurement
measurement of of all
all capital
capital market
market risks
risks (assets
(assets andand liabilities)
liabilities) in
in one
one system:
system:
Consistent
Consistent modelling
modelling of of all
all capital
capital market
market risks
risks
Use
Use Test
Test by
by applying
applying identical
identical methods
methods and and portfolios
portfolios inin risk
risk modelling
modelling andand steering
steering by by MEAG
MEAG during
during
the
the period
period guaranteed
guaranteed
Implementation
Implementation in in the
the software
software Algorithmics,
Algorithmics, which
which is
is available
available on on the
the market
market and and which
which is
is about
about to
to
become
become aa standard
standard product
product (used
(used by
by Allianz,
Allianz, AXA,
AXA, ING,
ING, Zrich
Zrich et et al.)
al.)
Group-wide
Group-wide access
access to to the
the system
system forfor asset
asset manager
manager (MEAG),
(MEAG), risk risk manager
manager (IRM),
(IRM), and
and CIO
CIO functions
functions
(ALM)
(ALM)
Transparency
Transparency withwith respect
respect to to portfolios
portfolios
and
and methods
methods used
used
Numerous
Numerous evaluations
evaluations for for different
different
purposes
purposes available
available
Partly
Partly based
based on on proprietary
proprietary datadata and
and
methods
methods (e.g.
(e.g. modelling
modelling of of risk
risk drivers,
drivers,
valuation
valuation functions)
functions)

17

Market risk modelling:

Stochastic risk drivers and valuation function in Algorithmics
Risk drivers Valuation function
Determination
Determination of of type
type and
and number
number of of risk
risk Previously
Previously first
first and
and second
second order
order approximation
approximation
drivers
drivers over
over all
all portfolios
portfolios used
used
Stochastic
Stochastic modelling
modelling ofof risk
risk drivers
drivers over
over aa time
time Step-wise
Step-wise migration
migration toto Full
Full Valuation
Valuation mode
mode
horizon
horizon of
of one
one year
year considering
considering thethe correlation
correlation from
from Q2-2010
Q2-2010 onwards
onwards (especially
(especially important
important for
for
structure
structure with-profits
with-profits business
business inin Life
Life and
and all
all derivative
derivative
positions)
positions)
Equity value Value of Put-
Equity option Delta/Gamma-Approximation
Black-Scholes (Full Valuation)
Black-Scholes (at maturity)
1

t0 1Y t Equity value

Frequency

VaR
Profit/Loss

18
 Munich Re

Operational risk
- representation within the MRCM

Process to determine ERC for operational risks

Scenario
Risk Stochastic ERC-determination
development
categorization modelling and allocation
and evaluation
Separation
Separation inin Development
Development of of Refinement
Refinement of of Scenarios
Scenarios within
within RIRI
primary
primary and
and representative
representative critical
critical scenarios
scenarios and
and PI
PI deemed
deemed
reinsurance
reinsurance scenarios
scenarios based
based (M&A,
(M&A, antitrust,
antitrust, uncorrelated
uncorrelated
segment
segment duedue to
to the
the on
on the
the chosen
chosen business
business Assumption
Assumption of of aa
different
different business
business categorisation
categorisation interruption
interruption ERGO)
ERGO) 50%
50% correlation
correlation
models
models (materiality)
(materiality) through
through techniques
techniques between
between RI RI and
and PI PI
Categorization
Categorization Setting
Setting from
from property //
property Tail-dependency
Tail-dependency
based
based onon business
business probabilities
probabilities and
and casualty
casualty modelling
modelling between technical
between technical
processes
processes severities
severities for
for the
the Use
Use ofof Bernoulli-
Bernoulli- and
and operational
operational
Based
Based on ORIC11--
on ORIC scenarios
scenarios (expert
(expert models 2
models for2 for the
the risks
risks
categories
categories estimates)
estimates) other
other scenarios
scenarios
In
In the
the future:
future: Link
Link
to
to ICS
ICS

The evaluation of operational risk within the MRCM proceeds along

the corresponding business processes.
1
ORIC = Operational Risk Insurance Consortium
2 19
Bernoulli-model: Model with a deterministic loss, which can occur with a specific probability exactly once (0-1-situation)

RISK RESULTS & OPPORTUNITIES

20
 Munich Re

Munich Re: A leading global (re)insurer

Premium
Premium breakdown
breakdown by
by segment 201011
segment 2010 Key
Key business
business segments
segments
bn Primary insurance Reinsurance
Reinsurance Property-casualty
Reinsurance
Property-casualty 5.4 (12%)
Leading
Leading expertise
expertise worldwide
worldwide for
for 130
130 years
years
15.4 (34%) ( 7%)
( 5%)2 Total Primary Full
Full range
range of
of products:
products: From
From traditional
traditional reinsurance
reinsurance to
to
Q14 2010 insurance alternative
alternative risk
risk financing
financing
Reinsurance 45.5bn Life: 6.4 (14%)
Life: 7.8 (17%) ( 3%) Diversification
Diversification A
A key
key success
success factor
factor
( 21%) Primary insurance
Munich Health Health Germany: Primary
Primary Insurance
Insurance
5.0 (11%) ( 31%) 5.5 (12%) ( 6%)
Germany-based
Germany-based withwith presence
presence in
in attractive
attractive growth
growth
Premium
Premium breakdown
breakdown by
by geography 201011
geography 2010 markets
markets in
in Eastern
Eastern Europe
Europe and
and Asia
Asia
Offers
Offers P-C,
P-C, life
life and
and German
German health
health insurance
insurance
bn Africa, Near and Middle East
Latin America 0.9 (2%) Multi-channel
Multi-channel sales
sales strategy
strategy and
and aa powerful
powerful new
new brand
brand
1.1 (3%)
Asia and
Australasia
Munich
Munich Health
Health
4.2 (9%) Total
Q14 2010 AA leading
leading specialised
specialised risk
risk carrier
carrier in
in selected
selected
45.5bn international
international health
health markets
markets
Unique
Unique selling
selling proposition:
proposition: Flexible
Flexible combination
combination of
of
North America Europe business
business models
models and
and products
products across
across healthcare
healthcare
12.1 (26%) 27.2 (60%) sector value chain
sector value chain
1
Consolidated figures.
2
2010 compared to 2009. 21

Breakdown of Group required economic

risk capital (ERC)

1
Risk categories broadly based on refined "Fischer II" risk categories recommended for standardised industry disclosures.
2
Credit (re)insurance included. 3 Default and migration risk. 22
4
The measured diversification effect depends on the risk categories considered and the explicit modelling of fungibility constraints.
 Munich Re

Summary of economic capital disclosure

Position
Position as
as at
at 31
31 December
December 2010
2010
bn 31.12.2010 31.12.2009

Available financial
29.6 28.4
resources (AFR)

Economic risk capital1 20.7 17.4

Economic capital buffer 8.9 11.0

Economic capital buffer after

7.4 9.3
share buy-back and dividends2

Solvency II capital Hybrid capital

1
Solvency II capital based on VaR 99.5%, Munich Re internal risk model based on 175% of Solvency II capital.
2 23
After announced dividend payout of ~1.1bn for 2010 to be paid in April 2011 and 0.4bn outstanding share buy-back.

Sensitivities of Munich Re Group's

economic solvency ratio

Economic
Economic solvency ratio11 Sensitivity
solvency ratio Sensitivity Key
Key observations
observations
% Opposite
Opposite interest-rate
interest-rate
Ratio as at 31.12.10 sensitivities
sensitivities in
in
reinsurance
reinsurance and and primary
primary
Interest-rate +100bps
insurance
insurance mitigate
mitigate
sensitivity
sensitivity at
at Group
Group level
Interest-rate 100bps Moderate
Moderate equity
equity
exposure
exposure leads
leads to
to low
low
Equity markets +30%
sensitivity
sensitivity
Economic
Economic solvency
solvency ratio
ratio
Equity markets 30% after
after impact
impact of
of combined
combined
interest-rate
interest-rate and
and equity
equity
Interest-rates 100bps/ market
market stress
stress still
still high
high
Equity markets 30%

1
Solvency ratio defined as Available Financial Resources (AFR) over capital requirement; AFR after announced dividend for 2010
of ~1.1bn to be paid in April 2011 and 0.4bn outstanding share buy-back. 24
 Munich Re

Reinsurer Credit Default Swap Spreads

Munich Re continues to enjoy a favorable credit outlook

April 2011 vs. April 2010

Company 5-Year 5-Year 5-Year

April 2010 September
2011

AEGON 150 110 304

Berk-Hath 107 96 199

Munich Re 69 47 99

RGA N/A N/A N/A

Swiss Re 116 96 203

25

1. Munich Re (Group)

2010 highlights Key achievements

Business
Business model
model Again
Again demonstrated
demonstrated strength
strength of
of diversified
diversified activities
activities as
as leading
leading global
global (re)insurer
(re)insurer

Results
Results 10%
10% growth
growth of
of gross
gross premiums
premiums written
written in
in 2010
2010
Favourable
Favourable net
net income
income ofof 2.4bn
2.4bn in
in challenging
challenging environment
environment (high
(high claims,
claims, low
low yields)
yields)
Annualised
Annualised RoRaC
RoRaC of of 13.5%,
13.5%, RoE
RoE 10.4%
10.4%
G
G ROI
ROI of
of 4.5%
4.5% -- solid
solid returns
returns within
within boundaries
boundaries ofof moderate
moderate risk
risk profile
profile
R
R
O
O Capitalisation
Capitalisation Group
Group equity
equity further
further strengthened
strengthened to to 23.0bn
23.0bn despite
despite attractive
attractive dividend
dividend and
and share
share
U
U buy-backs
buy-backs
P
P Strong
Strong capitalisation
capitalisation byby all
all relevant
relevant measures
measures (regulatory,
(regulatory, rating
rating and
and internal
internal model)
model)
Ability
Ability to
to further
further increase
increase dividend
dividend for
for 2010
2010 (+9%)
(+9%)
Risk
Risk Stable
Stable results
results despite
despite major
major nat
nat cat
cat losses
losses
management
management Enhanced
Enhanced utilization
utilization of
of Munich
Munich Res
Res risk-bearing
risk-bearing capacity
capacity to
to seize
seize business
business
opportunities
opportunities
Despite
Despite major
major claims,
claims, reinsurance
reinsurance remains
remains dominant
dominant earnings
earnings contributor
contributor to
to the
the Group
Group
Reinsurance
Reinsurance Cycle
Cycle management:
management: Underwrite
Underwrite tailor-made
tailor-made solutions
solutions and
and cancel
cancel underpriced
underpriced
business
business
ERGO
ERGO confirms
confirms positive
positive trend
trend net
net income
income atat 355m
355m more
more than
than doubled
doubled
Primary
Primary Insurance
Insurance
Successful
Successful introduction
introduction of
of new
new brand
brand strategy
strategy
Consolidation
Consolidation process
process well
well on
on track
track
Munich
Munich Health
Health
Expansion
Expansion of
of health
health business
business model
model across
across selected
selected areas
areas

26