TOPICS MAGAZINE Issue 2/2015

TOPICSMAGAZINE

The magazine for insurers Facts, markets, positionsIssue 2/2015

Autonomous drivingA whole new world behind the wheel

Geothermal energyElectricity from the depths of Africa

D&O insurance Secure with our new app

Digital revolutionAutomation is already changing the face of manufacturing. But how will it impact the economy? PAGE 18

Munich Re

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igital revolution · D&O

insurance · Geotherm

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ous driving

1Munich Re Topics Magazine 2/2015

EDITORIAL

Dear Reader,

The digital age is progressing more quickly than ever and has already changed production conditions in many industries. We in the insurance and financial sectors also have to prepare for fundamental change. But what impact will digitalisation have on the economy as a whole? Are we on the verge of mass unemployment and permanently low interest rates? Or will digital technology lead to a period of sustained growth? We discuss these issues beginning on page 18.

Significant changes are taking place in another sector as well: unmanned aircraft are being used commercially with increasing frequency, for example in monitoring technical facilities or in agriculture. Yet legal standards for their deployment are only now beginning to be developed worldwide. Find out how insurers can best deal with this situation, starting on page 10.

Managers are finding themselves under public scrutiny more than ever before. They have to make a variety of decisions daily and at the same time comply with numerous laws and provisions. Keeping an eye on all of these requirements is a challenging task, especially when a company operates internationally. With our D&O app, which we present in the article beginning on page 6, we can support managers in recognising the risks involved and insuring themselves against them in the best possible way.

Munich, September 2015

Torsten Jeworrek Member of the Munich Re Board of Management and Chairman of the Reinsurance Committee

NOT IF, BUT HOW

2 Munich Re Topics Magazine 2/2015

Unmanned aircraft are taking offDrones for all: Until recently no more than a gimmick in science fiction films, they are now very much reality. These unmanned flying objects with between four and eight rotor blades are small and highly manoeuvrable, featuring batterypowered motors and capable of carrying small payloads. No wonder then that the commercial use of drones is increasing, for example to monitor technical installations or agricultural production. But what changes can the insurance industry expect with the advent of this new technology? >> Find out more about this subject in the article starting on

page 10 or visit our website at www.munichre.com/topicsonline/drones

10


Hands off the wheel: Autonomous vehicles will make drivers obsolete.

The technical challenges involved in drilling for geothermal energy are immense. 28

AUTONOMOUS DRIVINGA whole new world behind the wheel 28 Technological advances will radically change the way insurers structure their motor policies.

LIFEA printed heart? 32 Just how advanced is 3D printing in medicine and what is its relevance for life insurance?

CLIMATE CHANGEAdaptation is the key to success 36 This is the conclusion of the latest IPCC report.

Editorial 1News 4Column 43Imprint

D&O INSURANCESecure with our new app 6Munich Re’s D&O Scout app helps managers to understand their own personal risk and to quickly find the right insurance partner.

DRONESUnmanned aircraft are taking off 10 As the commercial use of drones grows, we look at the potential implications for insurers.

TRENDSDigitalisation of the economy 18 Digitalisation is having a profound impact at many companies. But what impact will it have on the economy as a whole?

GEOTHERMAL ENERGYElectricity from the depths of Africa 24 Munich Re has developed a new policy to cover the exploration risk and to help ensure that sufficient investors can be found for geothermal energy projects.

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Contents

NEWS


New developments in automobile technology, such as autonomous and connected cars, will have a profound impact on society and insurance business. The University of Michigan’s Mobility Transformation Center (MTC) researches these developments and the changes they will bring. “Munich Re has agreed to become a cooperation partner of MTC in order to support their efforts to develop the foundations of a commercially viable ecosystem of connected and automated vehicles. Our objective is to better understand and manage the opportunities and potential risks that accompany these new technologies”, explains Mike Scrudato, who was instrumental in helping to set up this cooperation.

>> Follow our expert Mike Scrudato on Twitter: @mjsdado3

With the new module in the NATHAN Risk Suite, risk managers can now carry out natural hazard analyses anywhere in the world at any time, and compare assessments. Since NATHAN Mobile is directly connected to the NATHAN database, risk assessors always have access to the latest data.

The Overall Risk Score provides a quick overview. This shows an absolute figure for the severity level of the natural hazard risk for property insurance, incorporating the risks for earthquake, tropical storm, winter storm, tornado, hail, flash flood, storm surge and flood.

>> www.munichre.com/en/nathan

Eight out of ten Americans are now convinced that the climate is changing. This is the result of the first Climate Change Barometer, published by Munich Re America, Inc.

Nowhere else in the world are the insurance industry and its clients as seriously affected by the growing number of natural catastrophes as in North America. Among Americans, 71% believe we need to focus more on renewable energies in order to slow down climate change. Of those interviewed, 63% stated that they had invested, or want to invest, in protection against the consequences of catastrophes. Almost half of the respondents are insured against the consequences of natural events. Over 1,000 US citizens were interviewed for the survey.

USA Growing awareness of climate change

COOPERATIONFocus on autonomous and connected vehicles

NATHAN MOBILEAnywhere, any time

Personalia: Markus Rieß will assume his position on Munich Re’s Board of Management on 16 September 2015. The Supervisory Board appointed him to this position in the spring.

Outlook: There is a lot going on in China at the moment. Conditions for insurers are also changing, and not just in motor insurance. In an interview with Topics Magazine, Board member Ludger Arnoldussen gives his assessment of the Chinese market.

>> www.munichre.com/topics-online

History: It did not take long for Munich Re to become global market leader after the company was founded in 1880. However, to this day Munich Re remains barely known among the general public. Now for the first time, a book to be published this October will detail the history of the company from its beginnings through to the 1980s. The book shows how the business of managing risks has changed over the years. It is also a story of globalisation and highlights the setbacks and obstacles encountered in this process. It also gives a detailed account of the company’s role during the Third Reich.

>> Johannes Bähr, Christopher Kopper: “Munich Re: Die Geschichte der Münchener Rück 1880–1980“. C.H. Beck, 2015

News in brief


Munich Re Foundation celebrates its tenth anniversary

From Knowledge to ActionThe Munich Re Foundation was established in the spring of 2005. Since that time it has worked towards minimising risks and protecting people against natural hazards.

Topics Magazine: Munich Re Foundation is celebrating its first milestone birthday. What vision has the Foundation team pursued over the last ten years?

Thomas Loster: Munich Re is one of the world’s leading risk carriers. It therefore stands to reason that the Munich Re Foundation should use this knowledge and, as a humanitarian foundation, endeavour to help people at risk. In addition, we want to support Munich Re, which primarily offers sophisticated insurance solutions in economically strong countries, in the developing and emerging nations, as the people there have only limited access to our knowledge of risks. In these countries we focus our attention on the proliferation of microinsurance products. Disaster prevention is equally important to us. We want to make a difference in these countries, in the spirit of our motto “From Knowledge to Action”.

For a vision to become reality, you need the right conditions. What are the strengths of the Munich Re Foundation?

Our team is very versatile – and we pursue our work with passion. But we also benefit enormously from our benefactor’s expertise. Having Munich Re in your name opens a lot of doors.

In what areas has the Foundation been particularly successful?

Every year we organise the world’s largest microinsurance conference, with approximately 500 delegates attending from some 60 countries. A third of the participants come from the private sector, others include state representatives, regulators and NGOs. The fact that we have been able to firmly establish this event is an enormous step forward for the organisers working in development aid cooperation, and ultimately also for the people who can benefit from microinsurance. Together with the United Nations (UNISDR), we also award the highestpaid prize for disaster prevention, which supports outstanding projects. A third successful project are fog nets that harvest large quantities of drinking water from fog and dew for the people of the dry mountain regions in Morocco and Tanzania.

Despite all the successes, where do you encounter problems?

The Foundation is domiciled in Munich and must operate successfully in many different countries of the world. In our work we encounter the widest variety of cultures and strongly differing ways of thinking and working. You need a lot of em pathy to gain recognition. Working together with NGOs and local administrative units can also be very challenging.

You work with a Foundation capital of €50 million. Times are bad for interest earnings. How is the Foundation doing in financial terms?

From the start we invested our capital sustainably in a MEAG fund. This fund is very successful, with average earnings of approximately 4.5% per annum. We weathered the financial market crisis well and can use the earnings for our project work. However, the low interest rates will reduce our earnings in the long term.

What are your wishes for the future of the Foundation?

That we can improve the living conditions of many people enduringly and demonstrably. In concrete terms this means, for example, that we can save peoples’ lives with our flood warning system. Our projects are intended as blueprints and should be multiplied. We are happy that Munich Re appreciates the Foundation as a partner and look forward to continued good working relationships so that we can achieve as much as possible together.

>> For further information on the Munich Re Foundation, please visit www.munichre-foundation.org

Thomas Loster has been responsible for managing the Foundation since it was established in 2005.

NEWS

www.munichre-foundation.org

D&O INSURANCE


Directors’ and officers’ liability insurance protects board mem-bers, managing directors and other executive staff from the financial consequences of a wrong decision. A new app from Munich Re – the D&O Scout – helps managers to understand their own personal risk and to quickly find the right insurance partner.

Secure with our new app

The legal requirements imposed on managers have heightened considerably in recent years.

D&O INSURANCE


Christian Fuhrmann

Many decisions that executives take on a daily basis have to comply with innumerable laws and regula-tions. Keeping an eye on all of these requirements is a challenging task, especially when a company oper-ates internationally. To complicate matters further, regulations have been made even more stringent since the last financial market crisis. Government authorities and supervisory bodies are taking more drastic measures, in part because company execu-tives are more than ever in the focus of the public eye. Of course, none of this will prevent executives from making whatever decisions they see fit, but still it is reassuring for them to know they have the best- possible insurance cover.

Errors in judgement or breaches of duty can have far-reaching legal and financial consequences. Board of management members, managing directors and supervisory board members have full personal liabil-ity, meaning their own personal assets are at risk. They are liable to third parties such as shareholders as well as to the company itself. Any executives still operating without D&O cover today could be accused of committing an act of gross negligence against themselves.

Out-of-court settlements are the norm

Small and medium-sized companies in particular are not sufficiently aware of this problem. If they have any cover at all, then usually with a very low limit of indemnity. However, SMEs can be highly international – a factor which lays them open to liability scenarios. The reason why many fail to perceive the risk is that, apart from a few spectacular cases which have made it into the headlines or onto the agendas of share-holder meetings, such claims are generally handled very discreetly and settled out of court. Nevertheless, more recent examples have demonstrated how even high-profile executives can be subject to claims and sued for compensation.

D&O insurance, also referred to as management lia-bility insurance, protects against claims arising from a culpable breach of duty. It covers legal defence costs and compensation payments, should a top man-ager be personally liable. Even claims arising from gross negligence are usually covered. Virtually all major companies protect their executives from any unforeseen consequences by these means. And not without reason: in recent years, policies have paid out anything between US$ 1m and US$ 500m per claim – sometimes even more. If it comes to a liability lawsuit, a manager’s personal assets can soon dwindle to nothing.

Mergers and acquisitions are a frequent cause of action

The range of compensation claims is wide: share-holders, supervisory authorities, clients, employees and competitors are increasingly taking legal action to hold decision makers liable for their decisions. Such action may be prompted, for instance, by a com-pany launching undeveloped products on the market despite reservations among members of the research department, an insolvency administrator who sues former executives for selling company shares below their stock market value, or excessive dependence on one vendor whose supply problems pose a threat to the company. One area in which lawsuits are par-ticularly rife is mergers and acquisitions (M&A). Most D&O lawsuits in the last five years have involved transactions with volumes of over US$ 500m, espe-cially in the USA. The most common points of conten-tion in these cases are the magnitude of the buying price, the valuation of company shares or the failure to achieve predicted synergies.

And it is not only the top managers of corporations listed on the stock exchange who are exposed to these risks. The owners and managing directors of medium-sized companies and family businesses are at risk of being sued for actual or alleged mismanage-ment. Frequent causes include impeded career opportunities or discrimination.

D&O Scout establishes clarity

To make risks of this kind more transparent and thus more controllable, Munich Re has developed an app never before available in this form that runs on tablet computers. The D&O Scout not only provides com-prehensive information on the subject, it also enables users to transparently and discreetly determine their personal risk or that of their company. To do so, the interactive app poses a series of questions about the most important factors, and evaluates them. The risk assessment can be accessed as a PDF file, printed or sent as an e-mail.

Users can also contact primary insurers with long-standing ties to Munich Re via the app and receive advice on customised options for this type of insurance cover. The insurers we work with meet high-quality criteria and are familiar with the various international regulations in the countries in which they are licensed to do business. Naturally, app users can also select an insurer of their choice. In this case, the D&O Scout provides valuable tips about the most important criteria to keep in mind: minimum require-ments include a good rating, specialised know-how and a competent claims department.

D&O INSURANCE


D&O INSURANCE

D&O Scout – A look at Munich Re’s info app

Top managers are increas-ingly being held personally liable by shareholders, staff members, clients, competitors and regulatory authorities.

In recent years, D&O policies have paid out a number of individual claims in excess of €400m.

After the confidential self-assessment, managers can contact one of Munich Re’s specialist insurance partners listed in the app.


D&O INSURANCE

OUR EXPERT

Christian Fuhrmann is Head of the Global Clients/North America Unit at Munich Re and was instrumental in developing the [email protected]

With the growing awareness of management liability risk, D&O insurance has developed into a significant international market segment in recent years. It is already a standard building block in the risk man-agement of major corporations. The D&O Scout combines all of Munich Re’s global risk know-how of management liability insurance in an easy-to-use application. The app offers an innovative way for interested parties who are less familiar with the sub-ject to discreetly gain a quick overview of their risk situation.

With the help of our partners or other primary in -surers, it is now easy to find tailored solutions for protecting executives from liability claims.

Download the free app at:

>> Munich Re Homepage www.munichre.com/dando-scout

>> Apple App Store

>> Google Play Store

One key component of the app is the glossary: it con-tains over 90 terms on the subject of D&O insurance. The definitions are brief and to the point, and they include easy-to-understand legal background infor-mation. What obligations must a manager observe? In what countries is there a risk of being drawn into a class action suit? Or what special circumstances need to be considered in the USA? The app is rounded off by a quiz that users can take to reveal any informa-tion gaps.

Intuitive user interface

The D&O Scout cannot replace expert advice from lawyers, agents or insurers. However, it does provide a basis for managers to familiarise themselves with the subject matter. The Scout is available free of charge for tablet computers with an iOS or Android operat-ing system, and can be downloaded from the Munich Re website, the Apple Store or Google Play.

Despite the complexity of this subject, the app’s intui-tive user interface is so easy to use that all managers can quickly calculate their personal risk. Firstly, the D&O Scout interactively determines the degree of exposure based on the factors of region, the manag-er’s function within the company and potential claim-ants (e.g. competitors, employees, shareholders). The legal situation in individual countries is especially important. It will probably surprise many users that Germany, for example, has some of the strictest liabil-ity laws for managers. They must ensure that every law is followed to the letter. However, pressing claims in the case of violations involves wading through a great deal of red tape. Although you would expect this to be the true of the USA, liability law there is not as strict, and asserting claims is much easier.

Other factors determining the degree of risk are: industry, company size and type, and corporate governance. With information on the desired type of cover, the app finally calculates the overall risk situ-ation. On this basis, the user can then contact his company’s risk manager or a (tied) agent. Alterna-tively, one of Munich Re’s specialist primary insurance partners listed in the app can be contacted directly.

The details of the policy are decisive

When choosing the right policy, it is vital to ensure that the core elements adequately reflect the compa-ny’s main exposures. The policy riders frequently offered with such packages should only be given mar-ginal consideration during the selection process. Items of particular importance are the precise defini-tion of a loss event, the transparency of the insurance terms and conditions, and the nature and extent of the insurance cover. For international companies, it is additionally important to clarify if and in what way directors and officers in foreign subsidiaries are also covered.

https://itunes.apple.com/us/app/d-o-scout/id933825725

https://play.google.com/store/apps/details?id=com.munichre.doscout


Gerard Finley, Michael Janisch and Roland Küsters

Drones for all: Until recently no more than a far-fetched gimmick in science fiction films, drones are increas-ingly becoming reality. These unmanned flying objects, variously known as Unmanned Aerial Sys-tems (UAS), Unmanned Aerial Vehicles (UAV) and Remotely Piloted Aircraft Systems (RPAS), with between four and eight rotor blades are small and highly manoeuvrable, featuring battery-powered motors and capable of carrying small payloads. As prices drop – a simple quadcopter costs less than €100 – the number of remote-controlled mini-aircraft is steadily growing.

Although much more expensive, devices for profes-sional and commercial use are gradually gaining a foothold in the market, as are less expensive leisure drones for hobby users which have been used for many years. As a rule, drones for professional/com-mercial use generally carry a larger payload, have a greater range and more stable flight characteristics. They are equipped with electronic control systems of varying complexity, such as GPS systems to facilitate navigation.

The use of drones for commercial, non-military purposes is strictly limited in many countries. Yet as civilian use of these unmanned aircraft increases, the associated risks are becoming a major focal point for insurers.

Unmanned aircraft are taking off

Weight class in kilograms < 7 7–25 25–150 > 150

Wingspan (in metres) 0.38 1.16 3.4 18

Weight (in kilograms) 0.42 4.6 110 1,050

Maximum take-off weight (in kilograms) – 10 200 1,300

Number of motors 4 8 1 1

Maximum speed (in km/h) 47 32 220 314

Range (in kilometres) 0.25 – 180 180 (500 ext.)

Maximum flight duration (in hours) 0.18 0.21 6 20

Maximum altitude (in metres) – – 5,500 6,000

Battery-powered drones

Battery performance is crucial for the potential

flight duration; other factors include speed,

payload and wind conditions.

Civilian multicoptersFrom minidrone to jet:Unmanned aircraft come in all shapes and sizes. The majority of private and even commercial drones weigh in at under 7 kg. Alongside other factors, weight is a principal consideration for underwriting.


< 7 kg

7–25kg

25–150kg

> 150kg

PayloadDrones can carry different payloads depending on their size and weight. As often as not, the payload is a camera.

Motorised dronesTo remain stable in flight, drones need at least four drive systems (quadcopters), two of which rotate clockwise, the other two anti-clock-wise. Hexacopters and octocopters are used to carry heavier payloads.

DRONES

DRONES


regulations at present. In some markets, however, they are already used in agriculture and forestry to control pests or identify diseased plants. Drones have also been used in the film business, as they are less expensive than helicopters and more flexible than camera cranes.

Other potential uses include aerial photography for surveyors and for monitoring pipelines, electricity pylons, dykes or construction sites. Firefighters have experimented with drones to fight inaccessible fires without risking firemen’s lives, and insurers are work-ing on ways of using drones to asses risks and survey losses following natural catastrophes. Delivery appli-cations are still in their infancy, though logistics firms have already conducted initial tests. Likewise, pro-jects designed to provide internet access to people in countries with poor technical infrastructure have yet to make it beyond the test stage.

According to the US Federal Aviation Administration (FAA), commercial drones will soon become an every-day phenomenon. More than 10,000 unmanned flying objects are expected to be airborne in American air-space by 2020. In view of the growing number of potential uses, the market research institute Radiant Insight has estimated that the global market volume for drones will expand from US$ 600m in 2014 to US$ 4.8bn by 2021.

All unmanned flying systems can be classified according to weight, altitude, flying time or maximum distance (reach). Size is another key distinguishing feature: it ranges from the dragonfly-like micro-drone DelFly with a wingspan of 10 cm to drones with wings as long as those of commercial aircraft, which are used for military purposes. According to the yearbook of UVS International, an association of drone manu-facturers, there are more than 1,600 different types of drone worldwide, only 20% of which are used for purely commercial purposes.

Large variety of potential uses

Thanks to new technologies, some of which are of military origin and have been adapted by mobile com-munications and model-construction engineers, more efficient flying objects are being created at ever-lower costs. These devices are equipped with sophisticated electronic systems, as well as small lightweight motors which nevertheless deliver sufficient uplift. The final technological hurdle at present is battery capacity, without which extended flying times are not possible.

On a personal level, the use of small unmanned cop-ters or “model aircraft” – often fitted with cameras and controlled by smartphone – has become an increasingly popular hobby. Provided that certain conditions are met, they do not even require a licence to operate. Commercial use of unmanned aircraft, however, is less widespread, particularly in certain markets such as the USA, due to the lack of uniform

Drones can be used to inspect techni-cal facilities such as wind turbines, pipelines, electricity pylons, dykes or construction sites.


DRONES

Technical advantages

Rotary-style drones are extremely manouevrable, making them attractive for a multitude of applica-tions. Unlike helicopters, drones stabilise themselves automatically, permitting simple and intuitive control within a short space of time. This is due to sophisti-cated technology in which gyroscopes and accelera-tion sensors constantly measure the longitudinal and transverse attitude, and transmit the signals to a micro- processor. Many additional electronic safety elements are conceivable or are currently being developed.

Regulatory obstacles

The biggest obstacle preventing the spread of com-mercial drones is the absence of a practical legal framework permitting the safe integration of unmanned flying objects into civil airspace. At pres-ent, the regulations cover only private use, but differ from one country to the next. Weight, altitude and reach are usually important here. The commercial use of drones is not approved on a broad basis but rather only in specific circumstances (e.g. special case-by-case approval in the USA) or countries (e.g. France). In 2002, Australia issued CASR101, the world’s first statutory framework regulating the use of drones. In Japan, the Japan Agricultural Aviation Association under the aegis of the Ministry of Agriculture, For-estry and Fisheries, issued standards governing the use of drones in agriculture. What is needed, however, are rules improving safety to the same level as in manned aviation. There also needs to be a uniform definition of unmanned flying systems and of the legal situation involved. There have been clear moves in this direction in both the EU and the US, but numerous legal hurdles still need to be overcome.

US authorities are currently taking a fairly restrictive stance on drones. The FAA released a draft proposal of regulations in February 2015, which presented what many viewed as very conservative rules (e.g. maximum height 500 ft, only daylight flights permit-ted, flying near bystanders prohibited, must remain in the operator’s visual line of sight). The FAA process allows the public 60 days to provide feedback on the proposed rules. Over 4,000 responses were received by the FAA, which they indicate may take them 12 to 24 months to work through before final rules can be published. One item that received strong pushback from many industries was the visual line of sight requirement. In response, the FAA has engaged UAV manufacturers and technology experts in an effort to examine the viability of safely using BVLOS (Beyond Visual Line of Sight) technology. This is part of the FAAs “Pathfinder Initiative”, which will also explore technology that may allow urban and long-distance use of drones as well. The main stumbling block to this is the development of “sense and avoid” technol-ogy for drones. The systems used in commercial avia-

Drones allow directors to film spec-tacular scenes that would have been too costly or even impossible just a few years ago.

Postal deliveries to some remote islands are already carried out by drones.

Drones are already in frequent use in agriculture and forestry to inspect large fields or control pests.

DRONES


sciences bachelor programme. I would say there isn’t a single major school in the US that doesn’t have some programme focused on unmanned aircraft, either in the form of aerospace engineering like we have here at North Carolina State or in aviation sciences, emphasising flight training and airport management. And both sides are important because we expect to see more and more drones in use and training will be necessary, even for small aircraft. The FAA recently announced plans to introduce a regula-tory framework, which would include an operator cer-tificate and an FAA knowledge test for UAV operation that must be taken every 24 months.

Are you cooperating with the authorities to define the future regulations more precisely?

Yes. In fact, we’re working with the state of North Carolina to develop additional rules. We want to see knowledge of North Carolina’s own UAV laws included as a requirement to obtain a permit to fly drones in this state. We’re also cooperating with pri-vate flight schools that say they can teach the FAA requirements as soon as they’re established. In our view, it’s better to support the private sector in this area than to offer training at our university, because the demand is going to be so high.

What standards would you like to see applied?

The most important point is to ensure that drone pilots understand airspace and know the rules of the air. This will require a combination of pilot and instru-ment ground-school training to establish basic knowl-edge of how airspace works, as well as of the different types of airspace, communication with aircraft control and what to expect from manned aircraft and pilots in the airspace. But knowing how to fly a manned air-plane is pretty much irrelevant for flying many of the small aircraft emerging in the markets today.

Topics Magazine: What kind of training and education does NGAT offer at North Carolina State University?

Kyle Snyder: NGAT is the nerve centre for all unmanned aircraft activities in the state of North Carolina, so we’re deeply involved in coordinating education in all aspects of unmanned flight across the state. While we don’t offer training in drone flying here at North Carolina State University, our strength is educating aerospace engineers and computer sci-entists when it comes to designing better unmanned aircraft. In fact, students in our aerospace engineer-ing programme have been building UAVs as part of their senior design projects for the past 30 years.

What is the focus of the education?

Educating people in various fields on how to get maxi-mum benefit from the data captured by drones is also emphasised – how farmers using aerial photography can identify the condition of their crops or how sur-veyors can utilise drones to collect geographic infor-mation system data. This means going into GIS in depth and building up a full understanding of the dif-ferent types of information available. So we work with our Department of Remote Sensing to provide GIS training, giving them datasets from our flight opera-tions. A one-off course is currently available in drone LIDAR operations and imagery, i.e. using light and radar technology to map and measure distances.

Where is actual drone flight training offered?

Auburn University in Alabama has an unmanned air-craft flight school, which recently received Federal Aviation Administration (FAA) approval to offer com-mercial training. One of our partner schools here in North Carolina, Elizabeth City State University, is also starting a UAV operations programme, the actual piloting side of operations. It’s part of the aviation

As commercial drone use grows, the need for technological and operating standards is becoming increasingly pressing.

Can standards catch up?


tion are too large and heavy, and the technical prob-lems involved in miniaturisation still need to be resolved. Requests for specific exemption permits continue and are increasing (as are approvals), even as the authorities continue to work on broad-based regulations governing commercial use. Uniform stat-u tory regulations are not expected before the middle of 2016 at the earliest (and may be delayed further), and Europe is unlikely to follow suit before the end of 2016. Harmonised regulations – or preferably an inter-national agreement – are vital. Increasing pressure from various key industry segments may accelerate the development of workable rules, but that is not a certaintly at present.

Underwriting aspects

Drones that are used for commercial and private pur-poses are classed as original aviation risks. Traditional aircraft usually need to be insured. The insurance requirements for drones are not as straightforward. EU regulation 785/2004 requires a minimum sum insured of SDR 750,000 (€942,000) for model air-craft weighing 20 kg or more. In the US, however, there is at present no standard requirement for the insurance of drones, whether commercial or model in nature. This may change when the FAA releases its final rules. In principle, unmanned flying objects would be well served (whether required or not) to carry the same cover as general aviation, but without passenger insurance – in other words, aircraft hull including the control station, freight insurance, public and product liability. The problem today is that insur-ers are faced with completely new risks and are required to provide cover without the legal security of a consistent regulatory framework. This is also the reason why a genuine market for such covers has not yet developed. Only a handful of specialised insurers have built up a small portfolio of covers for drones within the framework of aviation insurance. The sums insured range from US$ 1m to US$ 10m and are therefore nowhere near the liability limits normally found in aviation insurance.

For smaller devices weighing up to 5 kg, covers are sometimes also requested and granted within the context of private liability or commercial liability, sub-ject to certain conditions. Inclusion in existing private or commercial liability coverage is generally advisable, however. Other large or more complex drone expo-sures may be better suited for special covers. The advantage of special covers is that they may permit a rapid response to changes in expected claims, for instance following changes in the regulatory environ-ment. A special cover may also be advisable when-ever drones constitute the main risk. Assessment of the individual risk is always advisable in the case of drones weighing over 5 kg. Product liability and drone hull are of no particular significance. However, these areas will become more important as systems become more widespread and more expensive.

DRONES

What are the main challenges you see arising as the commercial drone industry develops?

The big challenge is that the toothpaste is already out of the tube. It’s so easy to buy drones, and they’re so easy to operate now. The technology has matured so much in the past five years that it’s almost too late to put rules and regulations in place. One of the first things we ask is whether people operating a UAV are outside the 5-mile (8-kilometre) no-fly zone around the nearest airport, which is one rule that already applies. We find that many people just don’t know how to even determine that.

How could the insurance industry provide support?

It will be interesting to see what happens once the FAA publishes what it’s going to do in terms of formal law. With Amazon selling 3,000 drones a month in the US alone, I wonder how many of those people are going to actually go out and get a licence to operate commercially. The insurance industry will play an important role. A professional aerial photographer, for example, will be asked to show that he has the right qualifications when buying insurance.

Kyle Snyder is Director of the NextGen Air Transportation (NGAT) Center at North Caro-lina State University. The non-profit consor-tium involving academia, industry and govern-ment is focused on developing air traffic control, airspace management and flight safety related to unmanned aerial vehicle (UAV) integration.

DRONES


TerrorismUnmanned flying objects offer a new means of pene-trating sensitive industrial complexes or getting close to crowds in order to detonate a bomb. Experts are still debating whether civil unmanned flying objects could pose a threat to nuclear reactors. Numerous drones flying over nuclear power plants in France and Belgium have already alarmed authorities and operators.

PrivacyDrones fitted with cameras make it easy to violate other people’s privacy or image rights (accidently or intentionally) – for instance, when users pilot their devices over private property near windows, giving rise to the possibility to look inside people’s homes. As a rule, victims only file for an order to delete the images or for an injunction. Monetary indemnification is also conceivable, however, depending on the financial situation of the liable party and the severity of the intrusion.

Operational disruptionsThere is exposure near airports, if the sudden appear-ance of a drone results in temporary closure of the runways. Another potential scenario would be for a drone to damage a transmission line and cause a power outage.

Risk assessment

The main considerations for underwriting are operator qualifications, weight class, altitude, range, intended use and technical features. Potential damage on the ground depends on the kinetic energy resulting from the weight (including payload), altitude and speed. Form and material are less important. Even small drones crashing from a low height can cause serious bodily injury and property damage if they crash at full speed. Exposure increases considerably if the flying object is inside controlled airspace. Opinions as to the safe distance to be maintained between an un manned flying object and an airport range from 1.5 to 10 km.

Exposure is considerably lower when drones fly over open fields or are used in agriculture than when they fly over densely populated or heavily frequented areas (sports stadiums/pedestrian precincts). Following a number of incidents, the FAA has explicitly banned flights in the vicinity of sporting events.

Potential risks which lie beyond the scope of personal or public liability must also be taken into account, for instance in conjunction with professional liability. A cyber policy could be relevant if hackers penetrate the control system and cause the drone to crash, or use it for a targeted attack. Systemic faults in production or programming could lead to serial losses under the manufacturer’s product or professional indemnity pol-icy. Infringements of data protection laws (violation of personal rights through unauthorised images) are also classified as risks by the licensing authorities.

Conceivable loss scenarios

Credible loss data does not exist at present. Most of the few documented cases relate predominantly to drones used for private purposes or by the military sector, and offer little more than a rough indication. Spectacular cases, such as the drone which landed near the White House in Washington in January 2015, make the headlines but are only anecdotal. Based on the limited data that is available, the accident rate (frequency) appears to be higher for drones than is generally the case in aviation. After all, a drone may crash after the failure of a single motor and unmanned systems do not have the redundancies common in general aviation, nor the level of experienced operators comparable to traditional aircraft pilots. As their use increases, the following loss scenarios may emerge and must be monitored closely:

Crash and collisionProperty damage and bodily injury caused by errant or crashed drones must be considered here. The operator is a significant error source, particularly in the initial few years of growing use, as qualified oper-ators may take time to be developed. Crashes may also be caused by carelessness, insufficiently charged batteries or by exceeding the range. In addition, faulty design or assembly of the drones may cause acci-dents. Potential sources of defects in the product itself include faulty batteries, motors or control units. Possible major loss scenarios could, for instance, involve a flying object crashing on a motorway and triggering a mass auto pile-up, or colliding with an aircraft and being drawn into the jet engines. Pri-vate model aircraft have a technical reach of well over 500 metres today. A drone can pose a realistic threat to air traffic, particularly during take-off and landing. Drones could also crash into crowds, buildings or power lines, causing extensive losses.

In November 2014, the US aviation authority FAA disclosed that it receives about 25 reports each month of drones being observed close to aircraft.

DRONES


Altitude is the decisive criterion in determining a drone’s controllability. It is generally agreed that oper-ators can control their drones by sight up to an alti-tude of 120 m. What is disputed, however, is whether the maximum distance permitting good visibility and hence control is closer to 200 m or 500 m. This distance is reduced considerably if visibility is poor or obstructed. Technology is emerging that may make effective control possible beyond visual line of sight (BVLOS technology) and in the US the FAA is looking at such technology in depth.

Drones capable of finding their own way and safely circumnavigating any obstacles do not exist at present. Until such time as fully automatic flying objects have been invented, the pilot’s skills, qualifications and practical experience remain the most important criteria (see interview on page 14). Safety systems which automatically prevent collisions, stabilise the flying object and are equipped with intelligent soft-ware would reduce the risk accordingly.

Conclusion and outlook

Both economically and from an insurer’s perspective, drones are of modest significance at present. How-ever, this will change as soon as a practical regulatory framework is established and they are used more extensively for commercial purposes. As far as we know at present, there are no uses which would exceed the limits of insurability. At the same time, however, the risk landscape will change as the number of drones increases, the technology evolves and the legal landscape starts to emerge.

Where private use is concerned, hobby pilots can be all too unmindful of the risks. They rarely know the limits governing the permitted use of drones; in the worst case, they may disregard the rules entirely. In the commercial sector, strict regulations (once estab-lished) will help ensure that the claims frequency remains manageable. Users must expect to lose their licence if regulations are infringed; depending on the nature of the business involved, they can expect hefty financial penalties or may even be closed down.

Attempts by the insurance industry to develop model insurance conditions for drones are still developing. In the US, for example, a series of optional drone endorsements has been filed by Insurance Services Office (ISO) and received approval in virtually all states at last count. At the same time, several carriers are developing their own independent coverage forms. Legislative action is needed to fill the regu-latory vacuum. Munich Re supports its clients by providing the appropriate services for product devel-opment and risk assessment. We actively support our clients whenever insurance is required for the legal use of drones.

>> Find out more about this subject on our website: www.munichre.com/topicsonline/drones

OUR EXPERTS

Gerard Finley is Senior Under-writer for Casualty Treaty in [email protected]

Michael Janisch is a Senior Underwriter in C or porate [email protected]

Roland Küsters is Underwriter/Legal Counsel for Aviation in Special and Financial [email protected]

TRENDS


What part will human labour play in the future?

One thing is already clear: digitalisation will revolutionise the way companies work. But what impact will it have on the economy? Will it lead to mass unemployment and persistently low interest rates? Or will technological advances finally put an end to sluggish growth?

Digitalisation of the economy

TRENDS


Alexander Dietrich and Benedikt Rauch

Many people associate digitalisation and “industry 4.0” with computers and the networking of all produc-tion processes. Quite apart from the production of goods, however, digital tracking and management of processes can result in more efficient solutions, for instance in managing the networks supplying water and energy, or in healthcare. In addition, digitalisation can also have positive effects which are not reflected in the GDP. Intelligent management of energy con-sumption in the manufacturing industry or in the pri-vate sector can reduce emissions, for example, and improve the quality of the environment. In addition to therapies tailored to the individual patient, more accurate and more rapid medical diagnoses can lead to improvements in healthcare.

The Siemens factory in Amberg, Bavaria, is a practical example of a fully networked and automated produc-tion facility, a so-called smart factory. More than 75% of the processes there have been automated and all production objects can be clearly identified and located in the production hall via RFID chips (radio-frequency identification, meaning that objects can be identified with the aid of electromagnetic waves). The chip on the material informs the machine which production steps are to be performed, and also stores test and quality data. Innumerable sensors additionally record a whole variety of process states and parameters, providing extremely detailed and extensive real-time data for the employees controlling the production process. They are thus able to monitor production at all times and intervene if necessary. 50 million data records are accumulated in this way every single day. The machines form what is known as an “internet of things” in which they communicate with one another and coordinate processes. For example, machines can re-order materials automati-cally; these are then delivered without human assis-tance and used in the production process. The typical error rate of such intelligent production facilities is impressively low, with the result that very little man-ual rework is needed after the production process as such1.

Considering that many of the expected process changes in industry will be almost revolutionary in nature, this raises the question of whether the econ-omy will experience a fourth industrial revolution with far-reaching consequences. Optimistic advocates of progress believe, for example, that more and more products and services will be consumed at almost no cost in future. Pessimists on the other hand warn that ever-greater levels of automation will lead to mass unemployment.

Impact on productivity and economic growth

Technological progress – i.e. the continuous introduc-tion of innovations boosting productivity – is a major prerequisite for long-term economic growth. More efficient technologies and the digital networking of machines could boost labour productivity – the indi-cator most commonly used by economists to express the efficiency of production – in many sectors of the economy and thus stimulate further growth.

Optimists consider digitalisation to be the fourth revolution in economic activity, following the intro-duction of steam engines, assembly lines and elec-tronics. However, they believe this latest development is of a completely new quality. Unlike previous revolu-tions, such as the first industrial revolution with the steam engine, digitalisation could affect all areas of the economy. The diffusion of innovations is also pro-ceeding much more rapidly (see Fig. 1), and both eco-nomic and social upheavals appear to have become much more frequent. Consequently, estimates regarding the potential increase in economic produc-tivity as a result of digitalisation constantly outstrip one another. For example, a joint study by the Fraun-hofer Institute and the industry association Bitkom estimates cumulative productivity increases in Ger-many for the period up to 2025 of between 15% and 30%, depending on the branch of industry concerned; the machinery and plant engineering sectors in par-ticular, as well as manufacturers of electrical equip-ment, could experience even stronger growth2.

Fig. 1: Diffusion of innovations: Getting faster all the time

The time taken for innovations to reach 100 million users has become considerably shorter.

Source: BCG Research, ITU, Statista.

Telephone 75 years

Mobile phone 16 years

World Wide Web 7 years

iTunes 6 years, 5 months

Facebook 4 years, 6 months

Apple App Store 2 years, 2 months

WhatsApp 3 years, 4 months

Instagram 2 years, 4 months

Candy Crush Saga 1 year, 3 months(Smartphone game)

Year of invention

1878

1979

1990

2003

2004

2008

2009

2010

2012

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Employees’ wages and salaries will account for an ever- smaller part of the production costs. This could lead to a trend known as reshoring, namely bringing back production processes which were previously transferred to other countries. On the other hand, this development could apply pressure on the less modern (emerging) economies which serve as the world’s workbench on account of their low labour costs. For them, it will be difficult to narrow the development lead of the modern economies with their outstand-ingly qualified professionals. The qualification and further training of employees will become increas-ingly important in an ever-more computerised world.

Optimists expect that demand for qualified staff in industrial countries could rise significantly in the short term, in order to establish digitalisation throughout the production chain and build up the required infrastructure. In addition, they argue that the short-lived nature of products and the greater dif-ferentiation demanded by customers will make it impossible to replace humans in the production line, even in the future. They argue that people’s ability to learn and their flexibility are unrivalled and therefore

Yet what exactly will lead to these rises in productiv-ity? They will result from changes in the value chain, order processing, networking of machines and shop-floor management, wherever digitalisation is present. Greater flexibility in production is expected to ensure speedier responses to changes in demand; in addi-tion, digital simulation techniques make it possible to test new products without having to spend time manufacturing prototypes. In the event of failures in the value chain, so-called cyber-physical systems automatically search for alternatives or cut back pro-duction in order to optimise the utilisation of plant capacity. While mass production was the dominant aspect of “industry 3.0”, even the smallest batches of just one can be produced efficiently in this next stage.

Critics contend that the entire debate over digitalisa-tion is simply new wine in old bottles, as the comput-erisation and digitalisation of production have already been going on for some time and are by no means a new phenomenon. They also draw attention to the moderately positive effects of computerisation since the 1970s. Economist Robert Solow’s words “You can see the computer age everywhere but in the produc-tivity statistics” have become legendary. He claimed that information technology had not contributed any more to increasing productivity than other technolo-gies, and that there were major differences between individual branches of industry. Early studies on the measurement of productivity initially appeared to confirm the absence of a productivity boost, but their methodology is disputed. This is because an increase in productivity due to digitalisation was observed around the turn of the millennium. However, this posi-tive effect soon faded and was never so great that it could have been called a breakthrough, particularly as the increase in productivity has tended to decline in general in recent decades (see Fig. 2). So where do we go from here? Optimists believe that the positive growth effects of digitalisation will appear with time, and expect significant boosts in the future – particularly as all sectors of the economy will be affected. Pessimists on the other hand presume that digitalisation will at best be able to slow the downward trend in productivity, but will not under any circumstances herald an era of higher growth rates.

Will jobs be created or lost?

For the working world in highly developed national economies with a large proportion of industry, such as Germany, the digitalisation of industry could give rise to major changes. As production processes become increasingly automated, production costs will to a large extent be decoupled from labour costs.

Labour productivity (value generated by a worker in one hour of work) has improved continuously in the past, albeit less quickly (data show the 10-year moving average growth of productivity in %).

Source: The Conference Board – Total Economy Database

Fig. 2: Increase in labour productivity per hour

8

6

4

2

0

1960 1970 1980 1990 2000 2010

– Germany– France– UK– USA

“Estimates regarding the potential increase in eco-nomic productivity as a result of digitalisation constantly outstrip one another.”

TRENDS


far superior to any fully automated solution in times of global uncertainty and more volatile markets. Besides which, digitalisation has so far mostly con-cerned the manufacturing industry, thus continuing the existing trend towards enlarging the service sec-tor’s share of the value chain.

Sceptics, on the other hand, are confident that digital-isation will become a “job killer”. Increasingly intelli-gent, self-controlling systems lower the threshold of automation and lead to a higher degree of automa-tion, thus posing a threat above all to routine tasks currently performed by people. Studies estimating that roughly half the jobs in the United States and Europe will most probably become replaceable by computers in technical terms in the next one or two decades have caused quite a stir. According to the authors Frey & Osborne (2013), such jobs in the USA as “credit analysts, real estate agents and lock ten-ders”3 will almost certainly disappear and be replaced by others. “Social workers, psychologists and den-tists”, on the other hand, will almost certainly survive, as will other generally creative jobs (see Fig. 3). However, it is important to distinguish between a direct “destructive effect” and the eminently more significant net effect. The destructive effect merely considers the substitution of present-day activities without considering the creation of new jobs in other areas. The net effect, on the other hand, also covers newly created jobs. No matter how bold and simple such statements as the above may be, they initially only describe the destructive effect of current digital-isation trends and disregard new fields of activity.

Despite this, digitalisation could fuel the disparity in earnings. In other words, both high-income creative activities and routine tasks which cannot be auto-mated will be in great demand, leading to a “hollow-ing-out of the middle”. Occupations involving activi-ties of medium complexity but a high level of routine would be seriously threatened. Several researchers are certain, however, that the threshold of automation will decline in the long term, even where highly com-plex activities are concerned. It is ultimately a ques-tion of faith whether machines will one day be able to completely replace or even surpass human skills through autonomous learning and pattern recogni-tion. On the other hand, there have been many struc-tural breaks throughout economic history. Despite the considerable concern for jobs that preceded each of these upheavals, even the worst fears failed to materi-alise. There were losers, i.e. many occupations disap-peared, but there were many more winners: in most cases, higher productivity led to higher demand and generated new jobs. On average, global affluence has increased dramatically in the last few decades. Con-trary to the scenario of “mass unemployment”, new jobs could arise in the field of recreational activities, for instance, or the number of hours worked per employee could quite simply continue to decrease.

In what way could capital requirements and hence interest rates change?

It is not only jobs that could disappear as a result of digital technologies. Demand for capital could also decline if fewer investments are needed in the digital economy. This in turn could have a dampening effect on interest rates. Start-ups based on digital technol-ogies are often enormously successful and frequently require very little investment capital. For economist and former US Treasury Secretary Larry Summers, this explains the drop in demand for debt-financed investment and consequently also today’s low interest rates: “Ponder that the leading technological compa-nies of this age – I think, for example, of Apple and Google – find themselves swimming in cash and fac-ing the challenge of what to do with a very large cash hoard. Ponder the fact that What’sApp has a greater market value than Sony, with next to no capital invest-ment required to achieve it. Ponder the fact that it used to require tens of millions of dollars to start a significant new venture, and significant new ventures today are seeded with hundreds of thousands of dol-lars.” In addition, the rapidly growing number of inter-net and mobile telephone users has given rise to a “sharing economy”, in which items and general resources are jointly used for a certain period of time if they are not required permanently. Agency plat-forms, for instance in the taxi or hotel trade, can now set up international business models without requir-ing major investments.

The counterthesis is that digitalisation of the entire economy will require investments of gigantic propor-tions, thus supporting demand for capital and interest rates. Whether for automating and networking the entire value chain in production (smart factories,

Fig. 3: Which occupations could be replaced by computers and which will survive?

Activity Calculated probability of computerisation (in %)Healthcare social worker 0.35Dentist 0.44Economist 43Librarian 65Real estate broker 97Credit analyst 98

Calculations have been carried out to establish the probability of compterisation for different occupations (from a technical vantage over the next one or two decades). Here are some examples.

Source: Frey & Osborne (2013)

TRENDS


includes TV sets and “information processing devices” (e.g. notebooks and tablets), but also ser-vices which have become less expensive as a result of digital processes and sales channels (e.g. renting films, printing photos). According to recent calcula-tions by the Swedish central bank, products and ser-vices directly related to information and telecommu-nications technology account for 7% of the consumer basket in Sweden. In the last 15 years, the prices of these products and services have fallen by an average of 5% per year. In a hypothetical year in which the prices of all other goods and services rise by an aver-age of 2%, this drop in prices would reduce the rate of inflation to roughly 1.5%. However, prices for informa-tion and telecommunications products and services fell less sharply in 2013 and 2014 (between 2% and 3%) – the digital revolution was evidently not the main force keeping inflation low in recent years.

industry 4.0) or for installing and introducing new computer systems in the finance industry – a great deal of money is needed for hardware, software and training staff. Even the state infrastructure needed in the future (information and telecommunications tech-nology, energy supply and transport) will probably also be financed through debt. Studies indicate that, in the past 30 years, investments in information and communications technology (ICT) have contributed 0.4 percentage points to the average annual eco-nomic growth rate in the OECD countries, albeit with major regional differences. In the US and UK, they contributed more than 1 percentage point in the years around the turn of the millennium (see Fig. 4). Major growth contributions of between 0.4 and 0.7 percent-age points in Germany and the US in 2012 and 2013 would hardly have been possible without a considera-ble volume of investment.

Could the low level of inflation be due to digitalisation?

Several sound reasons indicate that inflation rates have been dampened by technical advances and par-ticularly the digitalisation of many economic activities in recent decades, as well as by other structural changes in the world economy (e.g. globalisation and deregulation). Technical advances can affect prices in several ways. The most obvious is the rapid fall in the price of electronic products in recent decades – and the enormous increase in performance at roughly constant prices. What is more, the internet and e-commerce have led to greater transparency, more competition and lower prices in some sectors. And conventional suppliers’ prices have come under pres-sure through the supply of (virtually) free products or services (e.g. open-source software, What’sApp). Automation has no doubt helped many business enterprises to contain rising labour costs and conse-quently price hikes. However, the effect of digitalisa-tion is not immediately evident in the inflation rates of recent years: although the drop in prices and higher quality of electronic products are reflected in statis-tics on consumer prices, these products account for only a small part of the average consumer basket of goods. The biggest expense items in Germany are “housing, electricity, heating” and “transport”. These are then followed in the shopping basket by the cate-gory “recreation and entertainment”, which not only

The number of percentage points that investments in information and communica-tions technology (ICT) have contributed to economic growth in the past varies strongly.

Source: The Conference Board – Total Economy Database.

Fig. 4: Major differences: Contribution of ICT capital to the rate of economic growth (in percentage points)

1.4

1.2

1.0

0.8

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0.4

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01990 1995 2000 2005 2010

– Germany– France– UK– USA

“The continuing spread of digitalisation is likely to have a dampening effect on infla-tion in the coming years.”

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The continuing spread of digitalisation is likely to have a dampening effect on inflation in the coming years, too – provided that the aforementioned forces of increasing efficiency and competitive pressure remain effective. These forces should cease to be effective, however, once the world economy reaches a state of “digital equilibrium”.

Could the effect on inflation be even stronger in future? This will probably only happen if technical advances also lead to increases in efficiency and fall-ing prices in other major consumer basket categories, such as the healthcare sector (a very prominent expense item for US consumers) or the supply of energy. Yet even if numerous inventions and speedy advances in productivity cause prices to fall tempo-rarily, years of “digital deflation” are by no means a foregone conclusion. After all, the central bank can take countermeasures in the form of an expansive monetary policy to achieve its inflation target.

Conclusion

Even if the exact effects of digitalisation on the four aspects discussed above are still not fully clear, there is no doubt whatsoever that it will bring major changes to the economic structures we know today. This in turn will generate opportunities for the insur-ance industry to develop solutions for these new busi-ness models.

>> Further reading:

1 elektrotechnik (April 2015): Special edition “Smart Factory”, p. 38

2 Bitkom & Fraunhofer IAO (2014): Industrie 4.0 – Volkswirtschaftliches Potenzial für Deutschland

3 Frey & Osborne (2013): The future of employment: How susceptible are jobs to computerisation

Bowles (2014): The computerisation of European jobs

OUR EXPERTS

Alexander Dietrich is an economist in Munich Re’s Economic Research [email protected]

Benedikt Rauch is an economist in Munich Re’s Economic Research Department. [email protected]

GEOTHERMAL ENERGY


Conditions around the East African Rift Valley are ideal for using geothermal energy. Munich Re has developed a new policy to cover the exploration risk and to help ensure that sufficient investors can be found for such sustainable power generation projects.

Electricity from the depths of Africa

Not just hot air: In some parts of the world, energy from deep inside the earth can be seen at the surface.

GEOTHERMAL ENERGY


Stephan Jacob and Matthias Tönnis

Deep down inside, the earth is boiling and bubbling – volcanoes, geysers and hot springs are a constant reminder of this. The deeper we go towards the earth’s core, the hotter it becomes, with temperatures reaching around 5,000°C at the centre. Geothermal energy technology harnesses this immense potential. It attempts to locate hot strata in the earth’s crust by drilling exploratory wells at suitable points in order to use the thermal energy present there.

Hydrothermal technology uses water or steam from deep hot reservoirs. The primary advantage of geo-thermal energy over other renewable energy sources is its permanent availability, regardless of weather conditions, time of day and seasons, and therefore its ability to provide base load power.

The risk: Unsuccessful exploration

The main downside of this technology is the enor-mous initial investment costs of exploration and drill-ing. The venture only pays off if sufficiently hot and plentiful water reservoirs are actually found. If not, the plants cannot be built or deliver the expected power. Experience has shown that the risk of unsuc-cessful exploration is not to be underestimated. Uneco nom ical operation of geothermal plants is a risk that project owners and investors must always con-sider, despite all their costly preparations and investi-gations. Munich Re has long promoted renewables as a carbon-free alternative to fossil fuels and has sup-ported geothermal projects since 2004 in its role as an insurer. And now we have developed innovative insurance solutions for deep geothermal ventures.

A new project insured in Kenya (Akiira) extends our portfolio to high enthalpy, a field which focuses on power generation. Hot steam is recovered from the depths and used to drive a turbine to generate elec-tricity. Very hot water reservoirs are needed for this purpose; ideally, the water should have a temperature of several hundred degrees Celsius. The world’s hot-test geothermal reservoirs with a temperature of 420°C are to be found in Larderello in Tuscany, where steam has been used since 1904.

Such reservoirs are primarily found in regions of tec-tonic activity, such as along the Pacific Ring of Fire (see world map above), in Mexico, Southeast Asia, Turkey and the East African Rift Valley. The reservoirs in this area are located at moderate depths of 1,500 to 3,000 m and can hence be accessed relatively easily for economically viable exploitation. On average worldwide, the temperature increases by only about 3°C for every 100 m into the earth’s crust, with the result that exploratory wells in less favoura-ble areas usually have to be drilled to depths of more than 4,000 m in order to reach economically viable reservoirs.

Insurance covers a minimum yield

For the Kenyan project, Munich Re has implemented a new coverage concept with its Multiple Well Risk Insurance: unlike the case in low-enthalpy regions, such as Germany, the projects comprise a portfolio of several production and injection wells instead of a doublet with just two wells. The minimum energy yield of a complete portfolio of wells is consequently insured in several project phases. Parameters for each phase are agreed between Munich Re and the project; these determine whether the project is to be aborted as being unsuccessful, thus triggering an insurance payment – or whether the promising results achieved merit continuation to the next phase. The process involves a close exchange of information and align-ment of interests between Munich Re and the project. An advantageous concept for both sides: balancing the higher risk at the beginning against the lower risk in later phases makes the project insurable and pro-vides investors with comprehensive security for the entire project term. The option of an early exit in the event of failure also serves the interests of both par-ties, as it limits the investors’ risk of financial loss.

A total of eight wells are insured in Kenya, with sets of two or four combined into one phase. Wells are deemed to be productive when the average energy output from all holes taken together reach a previ-ously defined output. This ensures that the more pro-ductive wells balance out those with lower output. If the wells’ output is lower than expected, stimulating measures to prevent losses are jointly considered and implemented where appropriate (see diagram on page 26).

If the average output reaches – or even exceeds – the reference value, the next set of two or four wells can also be drilled. When all eight wells have been com-pleted, the total output will be compared with the overall target agreed in the policy. Only then is the project deemed to have been successful or not.

Munich Re’s activities focus on regions with promising geothermal potential (high-enthalpy regions).

Well 1

Potential sitefor a planned

geothermalpower plant

Wells 2–8

Othernot insured

wells

Possible measuresto increase output(stimulation)

DeepeningSidetrackAdditional well

122

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3

Hot water/steamentering the borehole

Output in megawatts (MW)Munich Re insures the riskof not achieving su�icient

output in megawattsfrom geothermal wells

GEOTHERMAL ENERGY


Exploration risk insurance

Number of wells drilled

Exploration risk

Risk mitigation for geothermal projects

Geothermal heat offers an immense reservoir of base load energy. How-ever, the early drilling phase for pro-ject companies and investors is the most difficult one: if the targeted geothermal reservoir is unable to pro-duce enough output, the project is usually discontinued and the invest-ment is lost. Geothermal projects are therefore difficult to finance. With its Multi Well Exploration Risk Insurance, Munich Re covers the resource risk and helps ambitious projects to be realised.

Munich Re’s solution offers various advantages for investors and opera-tors. For investors, the availability of exploration risk insurance makes investments in deep geothermal energy projects considerably safer, more plannable and more attractive. Similarly, operators are in a better position to convince investors of the feasibility of ambitious projects and get them launched, since Munich Re, as a technically experienced and financially sound partner, will assume the risk of unsuccessful exploration.

Dim

ensi

ons

not t

o sc

ale

First wells bear the highest risk

GEOTHERMAL ENERGY


Ensuring that the insured wells achieve the desired result serves the interests of both the policyholder and Munich Re. However, if they prove unproductive in the initial phase, despite all possible stimulating measures taken, the partners can exercise an exit option. If the very first wells drilled do not deliver the minimum energy yield, it is highly likely that the pro-ject as a whole will fail to deliver as expected. Contin-uing under such conditions would mean both parties incurring high costs that they would prefer to avoid. On the other hand, part of the premium may be refunded if the project proves more successful than assumed.

Premiums are calculated individually for each project. The first step is to assess the project operator’s risk; this is then compared with our own assumptions, modified if necessary and transferred to a pricing model. Numerous parameters are taken into account, including the geological conditions in the region, data from adjacent fields and existing wells, as well as the policyholder’s particular needs.

Our risk analysis and the subsequent exploration risk insurance play an important part in proving the pro-ject’s technical and financial security and hence assuring its financial feasibility. It is frequently only possible to acquire private investors or capital provid-ers for geothermal projects during the planning phase if the project is insured against failure. Exploration risk insurance exclusively covers the minimum energy yield needed to operate a power plant in the first place. The insurance does not cover the risk that the plant will not achieve the cost-efficiency and return on investment expected by the investors or capital providers during its subsequent operation.

Kenya increasingly relying on geothermal energy

The chances are good that the insured Kenyan project will achieve the targeted power plant capacity of 70 MW electricity by the end of 2018. 500 MW from geothermal projects have already been installed at the neighbouring Olkaria field, just a few kilometres away. Geologists confirm that the potential for using geothermal energy is high in the area around the East African Rift Valley. The Kenyan government is pro-moting geothermal projects to cover the growing demand for electric power. According to Kenya’s national electricity company, the rising supply of electricity has already caused prices for private and commercial customers to fall by more than 30% since August 2014 (source: World Bank). The current pro-ject is financed by local and international companies, which also receive funds from the development bank KfW, and others.

Fund model in Mexico

This model, which attracts investors at an early stage with the aid of insurance, is also becoming popular in other countries, too. In Mexico, for instance, Munich Re has launched a similar programme together with the Energy Ministry, the development bank NAFIN and the Inter-American Development Bank. What distinguishes this programme is that Munich Re’s exploration risk insurance has been enhanced to form a unique complete financial pack-age for project developers:

1. Liability for the first commercial, non-insurable exploratory wells is transferred to a risk fund financed by the Inter-American Development Bank and Clean Technology Fund. Munich Re takes over liability for the subsequent wells.

2. The insurance premiums for these exploratory wells are partly subsidised by a premium subsidi-sation fund financed by the Energy Ministry.

3. The development bank NAFIN grants the projects a package of low-interest loans to finance all phases of the project; commercial banks would be unable to offer a package in this form.

Ultimately, all parties profit from such a public-private partnership, as it gives investors an attractive and comprehensive “turnkey” liability and finance pack-age; at the same time, it opens the door to geothermal projects in as yet unexplored regions.

OUR EXPERTS

Stephan Jacob is an underwriter in the Special and Financial Risks Division and is closely involved in Munich Re’s geo-thermal activities. [email protected]

Matthias Tönnis is a geologist. Before joining Munich Re as an underwriter, he managed deep geothermal drilling projects. [email protected]

AUTONOMOUS DRIVING


Can autonomous cars help to relieve con gested roads and prevent accidents?

What impact will autonomous cars have on the insurance industry? Mike Scrudato, Stefan Schulz and Jochen Friedrichs discuss trends and insurance-related aspects.

A whole new world behind the wheel

AUTONOMOUS DRIVING


Stefan Schulz: Let’s begin by looking into the near future. In what cars, do you think, will we be travelling in ten years’ time?

Mike Scrudato: I believe that in ten years automobile makers will have gone down the path of having many cars with advanced autonomous features on the roads, but the driver will be still in control, whereas technology companies such as Google, Apple or Uber seem to be working hard toward removing the drivers. Just recently, Google announced that they are going to put their fully autonomous vehicles on public roads in California. Although it wouldn’t be necessary, Cali-fornian regulations still require an installed steering wheel in these cars. It appears that partial autonomy is something tech companies want to leapfrog. Maybe both car manufacturers and tech companies are going to be right and we will have autonomous vehi-cles of levels three and four on the road.

Schulz: According to the NHTSA, the US Department of Transportation’s National Highway Traffic Safety Administration, there are five levels of automation. At level three the driver is still in full control of all safety-critical functions, while level four cars can per-form all safety-critical driving functions for the entire trip. What other differences do you see?

Scrudato: In general, we need to distinguish between autonomous and connected vehicles. The difference is that an autonomous vehicle can operate autono-mously, whereas a connected vehicle implies that vehicles are talking to another vehicle or talking to the infrastructure around them. Connected vehicles need an infrastructure in place. This is a critical point. In the US there’s not a lot of money available right now to maintain existing infrastructure, let alone build a new connected infrastructure.

Jochen Friedrichs: Can you describe the US situation regarding regulation?

Scrudato: In the US most of this is regulated at a state level. So there are 50 different states each with a Department of Motor Vehicles that governs the driv-ers, a Department of Transportation that governs the roads and infrastructure, and a Department of Insur-ance that governs the insurance products managing these risks. There are states such as Nevada and Flor-ida that already have regulation in place, but until you put the legislation on the books, there’s nothing that says you can’t put autonomous vehicles on the roads. So there could be autonomous vehicles driving through other US states without legislation.

Schulz: There are examples from other parts of the world. Singapore is planning a separate section in the city in which autonomous cars could drive around

without drivers and pick up people from their homes and take them to the next underground station. Imagine an area in a busy city where nobody has to be stressed out to find a parking spot! Many more infra-structure projects are planned in other countries – and everyone is looking at the developments of car manufacturers.

Scrudato: When we talk to car manufacturers we hear that the timeline might be a gradual evolution over a period of years. We are getting more connected every day and the cars are becoming more autono-mous with each passing model year. It’s just a matter of time how connected, how autonomous the cars will be. Is it going to take five years or ten years? Some of the variables are the cost of the technology and how much people are willing to spend.

Friedrichs: If we look back at developments in IT, all we know is that prices will go down much faster than expected.

Scrudato: Here is an example: the lidar device that is installed on cars with collision avoidance technology now costs half the price it was seven years ago. Top-tier suppliers estimate that the costs of this device in the model year 2016/2017 will be one sixth of the price in 2008. While prices of the technology will come down, the question that remains is whether technology will evolve to the point where you can get to level four and handle all conditions. I think that’s the wildcard. We still have to wait and see.

Schulz: The driver assistance systems that car manu-facturers put into cars right now help drivers with things they do not do well. These systems monitor whether the driver falls asleep or they take over in stop-and-go traffic. However, there are many things drivers do really well. Technology will have a hard time replicating the human brain to accomplish what people do instinctively.

Stefan Schulz, Head of the Motor Consulting Unit in Munich, Mike Scrudato, Strategic Innovation Leader at Munich Re in Princeton, and Jochen Friedrichs, Senior Motor Consultant.

AUTONOMOUS DRIVING


Friedrichs: With that comes a big moral dilemma. What level of reliability can we put up with? Occa-sionally, those systems will fail and cause accidents. Are we as a society prepared to live with that?

Scrudato: It’s amazing to me that, at least in the US, we as a society have become almost numb to auto-related deaths. We have almost 33,000 deaths a year. It is national news when a train crashes and eight people die. Whereas almost 100 people die every day in auto-related crashes. From a social responsibility standpoint, if there was a way to lower that number, we need to ask ourselves how we can be part of that solution.

Friedrichs: Many in our industry talk about a shift of liability towards car manufacturers. But even if cars drive automatically, there is always an owner who is liable. Can claims departments perhaps implement new procedures for direct liability to car manu-facturers?

Schulz: In the end, the insurance regulator wants the victims to be well covered. Who pays the bill in the end might be a different question. But I do not see an individual going to a car manufacturer to settle a car liability claim. That will continue to be the job of the insurers.

Scrudato: A lot of people are talking about the death of auto insurance but as cars get smarter and more connected, we will see a new type of liability: cyber liability concerning an autonomous or connected vehicle. Once there is a mobile connection installed in the car, the car will be open for hackers. It’s no differ-ent than an airplane, or your PC, or your server or your cloud provider. Those exposures are there. Cyber cov-erage is an area where we could see much growth in the next five to ten years.

Friedrichs: While motor third-party liability might become obsolete in many years, I believe cyber liabil-ity will compensate this potential loss in the motor business line. Insurers should start defining a clear strategy to develop products that include cyber liabil-ity coverage.

Scrudato: Crash avoidance technology or active safety technology is available today in both new vehi-cles and in used cars. We know that such systems are already having a meaningful impact on crash fre-quency and crash severity. In the US, the Insurance Institute for Highway Safety (IIHS) recently reported on the effectiveness of the various collision warning systems with automated braking. The IIHS noted double-digit improvements in terms of crash fre-quency. Many other technologies that are available now could also have a corresponding impact on crash severity.

Schulz: How will crash severity change when there are more automated vehicles such as the Google car on the road? Will we see more or fewer accidents?

Scrudato: It was interesting to hear in May 2015 that Google openly reported their cars had eleven acci-dents in one million miles of automated driving and another 700,000 miles of driving with someone behind the steering wheel. So in the 1.7 million miles these cars have driven in total, eleven accidents hap-pened. That’s twice the accident frequency of other cars in the United States. And that got all the head-lines in the media. But the accidents were minor. Google cars were rear-ended. To me the big revelation was not so much that these cars had accidents but that Google was saying that there are always going to be accidents.

Friedrichs: It’s simple physics. If you’re travelling at a rate of speed and your vehicle has a certain weight, there’s a point at which the vehicle cannot slow down if someone cuts in front of you.

Schulz: The interaction between autonomous cars and non-autonomous might lead to more accidents and more claims. The German Acatech Association believes that by 2030, 50% of the vehicles on the road will be autonomous. This means insurers will have to be prepared for such a situation in which more or less intelligent systems meet more or less experienced drivers on the road. However, I believe that the total amount of claims will not reduce substantially. While the frequency of claims might go down, severity will increase. More people will survive accidents. These people will spend more time in care. This is going to be more costly for insurers.

“ As cars get smarter and more connected, we will see a new type of liability: cyber liability.”

AUTONOMOUS DRIVING


Scrudato: There are many more challenges to address. For example: How to deal with the increasing trend of car sharing schemes and the decrease in car ownership? Who will purchase insurance in the future? And, if policyholders are no longer buying cars, how can we continue to insure them?

Schulz: At this point we as reinsurers can step in. We see what is happening in various markets and can compare experiences from one market to the other. That’s something where we can help our clients to do the right thing that fits into their portfolio. And we can be a sparring partner.

Friedrichs: I see our role as a reinsurer that should convince and overcome the reluctance of many mar-kets, especially as we have business schemes from the shared economy. It is up to us to break the resist-ance in the industry. Because there is so much poten-tial to engage in.

Scrudato: Insurers need to keep up with the pace of change. Technology is evolving, the regulation and legislation change almost on a weekly basis. It is time to be alert and to jump onto the innovation band-wagon.

>> You can find more information about autonomous driving (including the NHTSA’s levels of automation) at: www.munichre.com/autonomous-mobility

OUR EXPERTS

Stefan Schulz, Head of the Motor Consulting Unit in [email protected]

Mike Scrudato, Strategic Innovation Leader at Munich Re in Princeton. [email protected]

Jochen Friedrichs, Senior Motor Consultant. [email protected]

“Active safety technology is already having a meaningful impact on crash frequency and crash severity.”

LIFE


3D printing is one of the most fascinating innovations of our age. But a lot of applica-tions remain visions of the future.

As we so often read today, vital organs may soon be produced by 3D printers. But how advanced is this technology really and what is its relevance for life insurance? A status report.

A printed heart?

LIFE


Achim Regenauer

3D printing is one of the most fascinating innovations of our time. This technology purportedly has the potential to radically change numerous economic sectors and areas of our everyday lives. Many media reports tend to focus on the medical aspects of 3D printing – aspects which ultimately could affect both life and health insurance in the future. From an insur-ance vantage, it is therefore all the more important to continuously monitor medical progress and routinely analyse technological developments. Munich Re con-sistently does both, and has already been observing the use of 3D printers in the health sector for many years.

In regenerative medicine, expectations for 3D printers are high. The primary goal of this specialised field of medicine is to regenerate defective or destroyed cells, tissues or organs. The route to achieving it could include new treatment methods and drugs that spe-cifically stimulate the body’s own regenerative and reparative processes. The subfield causing the great-est stir in this regard is tissue engineering – the bio-technical reproduction of living cells, tissue structures or even entire organs in the laboratory, with the aim of subsequently transplanting them as “human spare parts”. What sounds like science fiction today, is set to become reality with the help of special 3D printers. Research institutions and biotech companies are working intensely to advance the development of these so-called “bioprinters”. But what exactly does this technology involve, where does research stand today and how realistic are its prospects in the medium term?

Current fields of application

Replacement body parts made with 3D printers are already in use today in orthopaedic and plastic sur-gery, as well as in dental medicine. This is because the prosthetics required in these fields can be manu-factured layer by layer in a 3D printing process in such a way that they precisely match a patient’s anat-omy. The blueprint for this additive manufacturing process is provided by three-dimensional, thin-layer body scans generated by modern computer tomo-graphy or magnetic resonance imaging. A series of images is created, which are converted by a software application into layer-by-layer printing instructions for the 3D printer. The printer then builds a three-di-mensional implant particle by particle from a special plastic into a shape that is an exact replica of the body part to be replaced, such as a tooth or the femoral head of a hip joint. The method is also already in use in plastic surgery, for instance for patients whose facial bones have been partially damaged in an acci-dent. The missing structures can be precisely repli-cated with the new technology and then implanted.

The vision: Fully functional printed organs

However, behind these research activities in tissue engineering lies a much greater vision: innovative 3D cell printers reproducing human tissue structures and entire organs. The functional principle of these bio-printers is similar to that of the 3D printers sold today in retail stores. The only difference is that they do not use layers of plastic materials to generate a defined, three-dimensional object, but rather a mixture of liv-ing cells and biocompatible matrices. Small, and in most cases relatively simple cell structures, such as cartilage, have already been produced using this method.

However, although they regularly draw a tremendous amount of attention from the media, it is still extremely rare to see cases that go beyond this purely experimental stage being documented in scientific literature. Examples include several individual cases of successfully transplanted artificial tracheae. What sounds to a layperson like a medical sensation, is on close inspection much less spectacular, because the human trachea is essentially comprised of simple car-tilage. In the documented cases, it proved possible to reproduce the individual structure of the trachea on a 3D printer. To this end, the implants were printed with a powdered, biocompatible plastic material and – in at least one case1 – additionally covered in a layer of the patient’s own stem cells, which can be taken from bone marrow, for instance. The advantage is that unlike in human-to-human organ transplants, the risk of transplant rejection is likely to be significantly lower.

The potential is tremendous …

In view of the chronic scarcity of suitable donor organs and the prospect of a significantly lower rejec-tion risk, the high hopes attached to printed organs are more than understandable. It can also be assumed that imaging processes and bioprinters will see dynamic advancement and, in conjunction with the progress in regenerative medicine and bioengineer-ing, open up entirely new possibilities. The potential is unquestionably great, but medical research still has a long way to go. Whether we will be capable in the future of printing human organs, such as a liver, heart or kidney, in the laboratory and then successfully transplanting them is something that cannot be pre-dicted today with any accuracy.

One relatively minor obstacle in this regard will be the anticipated high costs. However, if the chances of success are realistic, it will doubtless be possible to

1 Example of a young woman, mentioned in www.nature.com/news/3-d-printed-windpipe-gives-finant-breath-of-life-1.13085

2 Source: http://www.pharmazeutische-zeitung.de/ index.php?id=46662)

www.nature.com/news/3-d-printed-windpipe-gives-finant-breath-of-life-1.13085

http://www.pharmazeutische-zeitung.de/index.php?id=46662)

LIFE


What lies ahead for insurers?

There are no reliable answers to this question at this present time. The media hype surrounding bioprinters and printed organs is understandable considering the potential and the hoped-for medical possibilities in tissue engineering. As with any new technology that leads to new products or production processes, it is conceivable that bioprinting will have repercussions for third-party liability insurance. However, the nature and onset of these repercussions cannot be reliably predicted today. As part of our Group-wide emerg-ing-risk management and trend-monitoring activities in life business, we monitor technological develop-ments, including 3D printing, to ensure that we can respond to any new risk situations promptly. In health insurance, this is likely to have a medium-term effect on cost structures, since treatment costs will be high initially, although significant savings will hopefully emerge at a later stage (due to the improved pros-pects for a cure).

By contrast, these developments are of no relevance to life insurance business at present. This will change as soon as these new possibilities and treatment methods transition from basic research to successful and sustainable use in clinical practice. Any addi-tional consequences, for example from potential changes in mortality, cannot be reliably predicted based on what we know today. It goes without saying that mortality will decline further in the long term if vital organs can one day be printed and successfully transplanted, particularly in the case of elderly people with chronic organ disorders (e.g. kidney failure or cir-rhosis of the liver), but not until some time in the dis-tant future. We do not expect any significant change in the risk situation at least over the next ten to twenty years.

Regenerative medicine and the use of bioprinters have the potential to revolutionise medicine in many areas. Munich Re will therefore continue to closely observe and monitor developments. This approach will ensure that we can take timely action and develop suitable insurance solutions based on sound knowledge.

mobilise the investment capital required for research and development. After all, some 12,000 people2 in Germany alone are currently waiting for a suitable donor organ.

… but the hurdles are high

The medical hurdles, on the other hand, are much higher because the architecture and function of virtu-ally all organs and tissue structures are literally multi- layered and complex. Bioprinters would have to be capable of processing different cell types simultane-ously to imitate the shape and texture of organic structures. This still has not been achieved to perfec-tion even with relatively simply structured com-pounds, such as cartilage, which consists primarily of collagen and fibre materials.

Furthermore, anatomic copies alone are not enough, since organs and tissues in the body do not exist autonomously. Rather, they need a functioning con-nection to an organism’s cardiovascular and nervous systems in order to receive innumerable signals every second from other regions of the body and to fulfil their functions. In other words, regenerative medicine must find ways and means of integrating “printed organs” completely, and above all successfully, into an organism (connection to the cardiovascular and nerv-ous systems and the metabolism).

This leads to the next challenge: the question of the body’s reaction to biotechnically reproduced organs. Even if cell material from the body’s own stem cells is used exclusively for 3D printing, some risk still remains due to contamination with pathogens and antigens. While adverse reactions of the immune sys-tem could be suppressed with existing drugs, this would greatly diminish one of the greatest advan-tages of organ printing.

Good, small-scale opportunities in the medium term

At present, incipient approaches to tackling the medi-cal hurdles and challenges described above are all that is on offer. Meanwhile, difficulties of a more tech-nical, legal and ethical/moral nature remain to be addressed. According to all legitimate estimates, it will take at least another one to two decades before bioprinters can reproduce artificial organs and tissue structures for transplantation, and become estab-lished in routine clinical practice. However, bioprint-ers could come into routine use on a smaller scale in the short to medium term – for instance, for directly printing cells onto wounds or replacing sections of bone and skin. It is also conceivable that artificial tissue and experi-mental organ structures could be used to eliminate the need for animal experiments in preclinical studies during the development of new active drug ingredients.

OUR EXPERT

Achim Regenauer is Chief Medical Director at Munich Re and responsible for medical consulting and trend research. [email protected]


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NOT IF, BUT HOW


Higher temperatures are causing sea levels to rise. Mangrove forests are being planted in many areas to act as natural flood barriers.

CLIMATE CHANGE

Eberhard Faust

The Fifth Assessment Report of the Intergovernmen-tal Panel on Climate Change (IPCC), Working Group II (WGII), published in 2014, considers the scientific findings concerning climate change and its impact on various economic and service sectors, as well as the options available for adaptation. The sectors consid-ered include energy, water, transport, tourism and healthcare, as well as the insurance and finance industries. It also assesses the impact on the global economy as a whole. The aim of the international scientists nominated by the IPCC for this report was to review the latest available research literature and assess the level of confidence of the research findings to date. Among the key concepts featuring in the dis-cussion on the impact of climate change and adapta-tion measures, the concept of risk in particular plays a much more prominent role in this latest IPCC report.

In its latest report, the IPCC examined the impact of climate change on different sectors of the econ-omy. Conclusion: Adaptation is the key to success.

Adaptation is unavoidable

CLIMATE CHANGE


In this context, risk is considered to be a product of the probability of a weather-related event and its con-sequence, for instance in the form of a loss. The latter results from the destructible system (exposure) at a particular location and its vulnerability. However, other factors also influence exposure and vulnerability to weather-related events – the two parameters deter-mining a potential loss. In many parts of the world, the resilience of social systems is compromised by such factors as poverty, ineffective institutions and authorities, unregulated land use, water pollution, the absence of institutionalised risk transfer, and others. In a broad perspective, all these factors have an influ-ence on the magnitude of the risk due to weather- and climate-related events.

Although climate modelling methods have improved over the decades, substantial uncertainties continue to characterise climate change projections for individ-ual weather variables and regions. Meanwhile, if we look at projected frequencies and intensities of river floods as an example, measures to adapt to the changes expected must be initiated promptly, even if the projections are not entirely certain at this stage. The concept of “iterative risk management”, a key element of adaptation, outlines a pragmatic way of dealing with the problem of uncertainty (see Fig. 1).

Yet what impact will climate change have and which adaptation options are available for individual sectors of the economy, insofar as these have been studied to date? For our summary, we have chosen the energy, tourism and insurance industries. Not surprisingly, economic projections involve numerous assumptions and uncertainties.

Impacts on the energy sector

On the demand side, global energy requirements are expected to soar, particularly for the cooling of build-ings in the summer months; according to one study cited by the report, demand will rise from 300 TWh in 2000 to more than 13 times that level, namely 4,000 TWh, in the year 2050 and to over 10,000 TWh by the end of the 21st century. However, only about a quarter of this is attributable to climate change; the remainder is primarily due to rising incomes in the emerging markets in warmer climate zones and cor-responding changes in lifestyle. In developed coun-tries, demand for heat in winter will tend to decline as climate change progresses.

Fig. 1 Concept of iterative risk management according to IPCC 2014

A cycle of three fundamental ele-ments recurs over time: (1) Focus on the problem, (2) Analysis and (3) Implementation. It must be repeated time and time again to take account of new knowledge, e.g. improved cli-mate models, new political frame-work conditions, or weather-related events. The continuing advancement of learning is the basic structure.

Scoping

Identify risks, vulnerabilities and objectives

Establish decision- making criteria

Implementation AnalysisReview and learn

Identify options

Assess risks

Evaluate trade-offs

Implement decisions

Monitor

CLIMATE CHANGE


Solar energy is an important element in the regenerative energy mix. How effectively it can be used depends, among other things, on the intensity of solar radiation, which may alter as a result of climate change.

On the supply side, power generation will be affected. The efficiency of thermal power plants in particular will decline as ambient temperature rises; the produc-tion of energy will also decrease as the volume of suit-able cooling water declines. During heatwaves for instance, this can cause power plants to shut down completely. Particularly the southeastern USA, Europe, eastern China, southern Africa and southern Australia could be affected by major reductions in the supply of cooling water. In combination with carbon capture and storage technology, energy efficiency will decrease by a further 8% to 14% and the water demand per generated megawatt-hour may double.

Thermal efficiency losses can be compensated by using heat-resistant material for higher operating temperatures of (ultra)super-critical steam turbines; for example, process water can be reused and dry cooling towers employed to overcome shortages in the supply of cooling water. However, such adapta-tions will push up costs. Nuclear power plants can become a security risk, particularly in the case of extreme weather-related events (EWE) – a reliable connection between the main components (reactor pressure vessel, cooling systems, control systems, emergency power generators) is essential for safe operation and shutdown; a sustainably reliable con-nection to an operative power grid is also important for the cooling and control systems during a shut-down.

Hydro power is the biggest contributor of renewable energy in the current electricity mix. Climate change has a complex effect here, due to the interaction of seasonal precipitation, its temporary storage as snow and in glaciers, and temperature-driven evapotrans-piration losses. A study has indicated that, up to 2050, the impact of climate change including EWEs will be moderately positive in most regions (e.g. Asia +0.27%) and moderately negative in Europe (–0.16%). In the long term, we must adapt to the gradual change in the availability of water; EWEs call for hard meas-ures, such as higher dykes, bypass canals and similar structures, but soft measures will also be needed, such as optimised management of the water released from reservoirs.

The use of solar energy in the form of thermal heating (TH), photovoltaics (PV) and concentrated solar power (CSP) is susceptible to changes in solar radia-tion on the earth’s surface, for instance as result of regional changes in the frequency of cloud cover. Technologies which can operate with diffuse light, such as PV collectors with rough surfaces or evacu-ated tube collectors, are advantageous in regions in which cloud cover is expected to increase. CSP on the other hand depends on direct solar radiation, although its vulnerability could be reduced slightly by installing a sufficient volume of heat storage. Such EWEs as gale force winds carrying sand or dust and hail pose a major challenge, as for example dust

deposits reduce the efficiency of solar collectors and increase the cost and effort involved in cleaning. More resilient materials are being sought in technological adaptation development projects.

Temporal (yearly and seasonal variability) and geo-graphical shifts in wind resources due to climate change will be key issues in the field of wind power. A study for the USA projects that, in the period 2041–2062, the average annual energy density from wind resources should remain at around plus/minus 25% of the conditions within the grid during the period 1979–2000. However, little is currently known about possible changes in yearly or seasonal variabil-ity.

Needless to say, innumerable further interactions also come into play, such as new and shorter shipping routes through the Arctic. Pipelines are particularly at risk from climate change due to rises in the sea level (near coasts), flooding, wet landslides, wildfires and permafrost melt. Power grids are threatened by strong winds, falling trees, wildfires and freezing rain. Modi-fying technical standards is a means of adaptation.

From a macroeconomic vantage, a small number of studies show that the energy-specific impact of cli-mate change – particularly that due to rising tempera-ture – will probably have a more negative effect on the GDPs of emerging nations than on those of developed countries. However, even in developed countries, the

CLIMATE CHANGE


effects may be substantial, for instance in the case of heatwaves and dry periods: for a scenario with two dry years in Nordic countries (25% lower inflow), a study projects that electricity prices will double for a period of two years. A US drought study has projected that electricity prices will rise by 8% (November) to 24% (July) as a result; for Germany, increases of 11% to 24% (with marginal power generation) or 50% (partial shutdown) have been projected. Meanwhile, computable general equilibrium (CGE) models cur-rently estimate that temperature-based changes in GDP resulting from developments in the energy sec-tor will only reach low single-digit percentages by the end of the 21st century – a negligible level. Almost all of these studies only address the effects on demand, however, and mostly disregard the costly impact of extreme weather-related events, such as drought and heatwaves. GDP losses could therefore be greater than assumed in the research literature available today.

Another cost factor is the topic of climate change mit-igation measures for energy systems, which is not a particular focus in our context. The challenge here is the fact that the total contribution of low-carbon tech-nologies to world primary energy generation must be increased by around 310% of the 2010 level by the year 2050 if the 2°C limit is to be achieved with any degree of probability.

Tourism will also change

Where tourism is concerned, the cooler countries – most of which also happen to be the wealthier coun-tries – will profit, while the warmer and mostly poorer countries will lose out in the long term. Models indi-cate a global welfare loss as compared with a future without climate change. Deterred by rising tempera-tures, tourists will favour higher altitudes (mountains) and higher geographical latitudes over hot regions; the majority of holidaymakers come from northwest Europe and will increasingly travel within their own region. On the supply side, winter skiing resorts, for example, will increasingly recede to higher altitudes where snow is guaranteed, while the overall number of such resorts will dwindle. Artificial snow cannot fully make up for the decrease in real snow (growing water shortages, costs, customer preference). Alter-native forms of tourism could become drivers of eco-nomic development in future. On the demand side, tourists visiting the Mediterranean could increasingly favour other seasons (spring/autumn) and other regions as summer temperatures and humidity levels mount.

Tourism will change significantly as a result of climate change. Skiing resorts at lower altitiudes are already feeling the change, as rain falls more often than snow.

CLIMATE CHANGE


Challenges for the insurance sector

Unlike many other sectors of the economy, the insur-ance industry does focus on assessing the economic impact of changes in extreme weather-related events due to climate change. Correlated nat cat risks are primarily affected by changing distribution properties for EWEs. However, in the discussion on trends observed in normalised insured nat cat losses, scien-tific methods for the attribution to specific causes (natural climate variability/anthropogenic climate change, adaptation) still hardly play a role. Few analy-ses deliver an in-depth study of the changes in nor-malised losses in conjunction with causative meteor-ological or hydrological parameters, such as changes in losses due to severe thunderstorms in southern Germany and the USA or losses due to drought- related subsidence in France. Studies on the projec-tions of insured losses due to climate change are like-wise still in their initial stages; they have so far only been performed for torrential rain/flooding, river floods, hail and winter storm in a small number of mid-latitude countries, as well as for tropical cyclones in tropical and subtropical regions.

The studies available to date already indicate clear changes in a number of hazards and regions. One study, for example, has projected that in Germany the mean loss ratio in homeowners’ insurance caused by hailstorms will be almost 50% higher in the period 2041 to 2070 than it was between 1984 and 2008.

As weather-related events become more frequent and more intensive, the challenge for insurers is that larger claims and greater variability in claims require higher actuarial reserves on the one hand, while cov-ers must remain affordable on the other. In addition to this, emerging countries are facing a specific situa-

tion. Here, insurance accounts for only a small part of the risk financing for natural catastrophes. Fre-quently, such countries primarily depend on interna-tional credit and donors in the wake of such events. The resultant “financial gap” in the funding of cat-astrophe losses may widen as climate change pro-gresses. Precisely in such cases, the development of insurance systems constitutes a form of adaptation, reducing the local government deficit following a dis-aster on the one hand and increasing the potential for risk diversification in the globally networked insur-ance industry on the other. Insurance covers for entire countries are another possible means of reducing the “financial gap” in the funding of catastrophe losses in emerging countries.

Index-linked insurances are currently being discussed for emerging countries, particularly for agricultural risks. For instance, instead of assessing claims indi-vidually, cover can be triggered by a precipitation index when a threshold value is exceeded at a repre-sentative weather station. The system offers indisput-able advantages: payments can be made very swiftly without costly loss estimates and the loss cannot be influenced by the policyholder’s behaviour. One disad-vantage is that mistrust may become endemic if cover is not triggered despite individual claims (basic risk). What is more, many index-linked insurances are cur-rently only used in small-scale pilot projects – it is not clear whether they would also work on a larger scale. Improvements are possible if the index is applied to an aggregate portfolio, based on the yield per unit area or on measurements via satellite remote sensing. Besides the new index-linked products, loss-based multi-peril crop insurance systems which do not share this basic risk have long been established.

CLIMATE CHANGE


How can nat cat insurance systems remain resilient?

The incentive to reduce risks through risk-based products and prices remains a key element. Systems which send out a clear message in this respect include hazard zoning systems, such as HORA (Aus-tria) and ZÜRS (Germany) for pricing the risk of river floods. Graded, more or less homogeneous risk groups are created in this way. In practice, however, risk-adequate premiums are seldom strictly imposed, often hindered by bundling perils under one cover and cross-subsidisation, price competition or even regula-tion; in some cases, there is a lack of risk awareness on the client side. Another important factor could be initiatives coordinated between the insurance indus-try and governments for the sake of risk reduction, for instance based on improved building codes. Risk models should take into account the change in loss distribution over time, as has already been done for the increase in hurricane activity over the Atlantic since the mid-1990s. Globally diversified reinsurers also play a decisive part in increasing the insurers’ risk-related actuarial reserves; capital market prod-ucts, such as catastrophe bonds, are also offered on the market when particularly high catastrophe financ-ing is required.

The degree of uncertainty still surrounding current attempts to aggregate the costs due to climate change over all economic sectors on a global scale does not inspire any confidence in the estimates avail-able at present. The studies included were all pub-lished over the last 20 years; for an additional temper-ature rise of around 2°C, they posit a global income loss amounting to between 2% and 3% at the upper end of the range – which would be a negligible amount. The IPCC report stresses that the actual loss effects are more likely than not to be greater than the figures quoted above. The high level of uncertainty is attributable to the different sub-sets of the global sec-tors considered in each study, as well as to different

and sometimes controversial assumptions concern-ing, for example, discounting rates, loss functions, intersectoral dependencies, and adaptation meas-ures. In addition, potentially significant influences, such as the possibility of catastrophic changes or tip-ping points in the climate system, were generally not considered. Virtually no research has been under-taken on the effect of an additional temperature rise of more than 3°C.

More than any of its predecessors, this Fifth Assess-ment Report focuses on climate change adaptation. Change is unavoidable in many sectors of the econ-omy – and adapting to the consequences as part of an iterative risk management will become the key to success.

OUR EXPERT

Eberhard Faust is Head of Research in Munich Re’s Geo Risks Research Division and contributed to the IPCC Fifth Assessment Report as a lead author of the chapter “Key eco-nomic sectors and services”[email protected]

Sources

IPCC, 2014: Climate Change 2014: Impacts, Adaptation, and Vulnerability. Part A: Global and Sectoral Aspects. Contribution of Working Group II to the Fifth Assessment Report of the Intergovernmental Panel on Climate Change [C.B. Field, V.R. Barros, D.J. Dokken, K.J. Mach, M.D. Mastrandrea, T.E. Bilir, M. Chatterjee, K.L. Ebi, Y.O. Estrada, R.C. Genova, B. Girma, E.S. Kissel, A.N. Levy, S. MacCracken, P.R. Mastrandrea, and L.L. White (eds.)]. Cambridge University Press, Cambridge, United Kingdom and New York, NY, USA, 1132 pp.


COLUMN

Michael Menhart, Chief Economist at Munich Re [email protected]

Iran: Outstanding opportunities, huge hurdles

Economics from a risk perspective

But the Iranians are not the only ones poised for an economic boom – many other national economies with high export rates are also waiting in the wings. The financial and insurance sector can also benefit from the tre-mendous amount of catching up the country has to do. With a premium volume of around US$ 9bn, Iran is already one of the biggest primary insurance markets in the MENA region. For the period up to 2025, premium income is expected to grow by an annual average of between 5% and 6% after adjustment for inflation, yielding a premium volume equiva-lent to US$ 19bn. That would be around the current size of the Polish insurance market.

The latest political developments and Iran’s enormous economic potential give grounds for hope. But it is still too early for celebrations. It will take some time before the Ira-nian government can win back the trust of the international community, and the Iranian economy that of inter-national investors. Accomplishing this will require more than just an agreement on Iran’s nuclear activities.

After many years of tough negotia-tions and innumerable setbacks, the nuclear agreement between Iran and the western powers was finally signed on 14 July. The economic sanctions imposed on Iran will now gradually be lifted: a major opportu-nity – for Iran itself, as well as for many international trading partners.

The sanctions have hit Iran hard. The country is excluded from the inter-national payments system SWIFT and trade with the rest of the world is extremely restricted, as is the export of oil. Since the UN Security Council imposed the sanctions in 2006, Iranian economic output has increased annually by an average of just 2.3% – a disappointingly low fig-ure for an economy at this stage of development. The population is struggling with annual rates of infla-tion near 20% (2014). Economic iso-lation has cut Iran off from the global finance markets; only a handful of countries still trade with Tehran.

This has left the country in sore need of economic stimuli, but major eco-nomic hurdles must be cleared if it is to become a regional economic power again. The lifting of sanctions will not spare the country from pain-ful reforms. For years, economic iso-lation has prevented technology transfer, lack of investment has last-ingly weakened production potential, and corruption is stunting all dynamic economic development. The country must first regain the trust of international trade partners.

At the outset at least, such partners will consider the overall political cli-mate to be fragile and will shy away from major investment.

At the same time, the dramatic fall in oil prices to below US$ 50 at times last year has dealt another blow to the Iranian economy. The national budget depends on oil exports. A break-even budget can only be achieved with an oil price of around US$ 130. Fiscal policy must therefore be placed on a new and more robust footing – with moderate tax in -creases and a more efficient system of tax collection. Con soli dation of expenditure and reform of the finan-cial system are also unavoid able.

The road to Iran’s re-emer-gence as a regional eco-nomic power may be rocky, but worth the trouble. Even though the road is rocky, it will be worth pursuing for both Iran and the rest of the world, for the country’s economic potential is immense. With around 80 million inhabitants, Iran is already the second largest country in the MENA region today, after Egypt. A quarter of the total population is under 15 years of age; the pool of young people (who are often very well educated) is enormous. And Iran has a large, often commercially suc-cessful middle class. Absolute growth in economic output in Iran between now and 2020 will probably be the second highest in the region after Saudi Arabia.


Picture creditsCover: Martin Poole/Getty Imagesp. 1: Robert Brembeckpp. 2, 4 left, 34, 39: shutterstockp. 3 left: picture alliance/Eizinger Alexpp. 3 right, 28, 36/37: Corbisp. 5: Oliver Jungp. 6: Westend61/Milton Brownpp. 9, 17 middle and bottom, 27, 34, 42: Foto Meinenpp. 10/11, 26: Illustration C3p. 12: picture alliance/Jochen Eckelpp. 13 top and bottom, 41: picture alliance/dpap. 13 middle: picture alliance/ZBp. 17 top: Taylor Photo, 2011 p. 18: Dan Herrick/Getty Imagesp. 23: Blende11 Fotografenp. 24: Daniel Bosma/Flickr RM/Getty Imagesp. 29: Oliver Soulas p. 32: Maciej Frolow/Photographer’s Choice RF/Getty Imagesp. 40: Seb Oliver/Stone Sub/Getty Imagesp. 43: Kevin Sprouls

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