Swiss Re falls short, strategy shifts in softening reinsurance market

It is the turn of the largest reinsurance companies in the world to announce their results this week, beginning with global reinsurer Swiss Re who today reported quarterly results which, while missing analysts expectations, showed a change in strategy.

Swiss Re has shifted further away from natural catastrophe reinsurance business during the quarter, replacing it largely with an increased amount of casualty reinsurance being underwritten. With competition high in the property catastrophe reinsurance market, Swiss Re has adopted the same strategy as most other reinsurers, shifting away gradually from some unattractively priced business, in search of better returns in markets like casualty.

Swiss Re missed on analysts earnings expectations for the quarter, although net profit was up 2% at $802m this fell short of the analysts consensus. The reinsurers combined ratios were also above analysts expectations, but with the shift in strategy this is not a surprise in the current market.

Swiss Re continues to navigate the market by moving away from property catastrophe reinsurance. Prior to the July renewals Swiss Re’s renewal book was 32% casualty and 30% natural catastrophe, but after the recent renewals it now estimates the business mix to have shifted considerably to 42% casualty risks and 27% catastrophe exposures.

Interestingly, Swiss Re also shrank its property and specialty books at the renewals, perhaps a reflection that so many other reinsurers are now targeting these areas that the business became less attractive to Swiss Re and that casualty outshone in terms of potential performance.

This shift towards casualty reinsurance is expected by analysts to result in a higher combined ratio, which typically goes hand-in-hand with longer-tail casualty risks, which over the short to medium term could see the firms results miss again. However, an interesting point to note is that Swiss Re is placing an increasing focus on making the most of the longer-tail casualty business to invest premium assets for longer.

Underwriting longer-tail, casualty and lower-volatility business, while boosting profits thanks to the longer investment duration of the premium float? Is Swiss Re’s strategy beginning to resemble the strategy of a hedge fund backed reinsurer?

In the P&C part of its business, perhaps. In the current market environment, being able to capitalise on investment returns to offset declining rates and the perhaps total loss of some profitable areas of the market (such as Florida peak catastrophe risks) to alternative capital and insurance-linked securities (ILS), an asset side boost will be welcomed.

But of course Swiss Re remains a globally diverse, in terms of lines of business and regions operated in, reinsurance business with life, health, specialty, property, catastrophe and increasingly casualty revenue streams.

Group CEO of Swiss Re Michel Liès said that the firm can continue to be selective in the risks it chooses to underwrite. Swiss Re is in the enviable position of not being “slaves” to any one area of the market, he said, which enables it to adjust its strategy accordingly to take advantage of the best opportunities which will help it to meet its long-term financial targets.

An increased focus on investment returns, helped by the longer-tail, longer investment duration casualty growth, is now a feature of Swiss Re’s business which it intends to leverage.  By shrinking natural catastrophe exposure and growing casualty it expects to benefit from the longer-tail nature of casualty allowing it to make more profit on the investment side of the business.

If executed correctly this strategy could see Swiss Re outperform in years to come. When the investment returns are particularly good it will no doubt more than offset the lost income from peak catastrophe underwriting it has not continued to underwrite. However, if the investment environment takes a turn for the worst, Swiss Re could find itself increasingly exposed with results that disappoint.

Interestingly, despite this strategic shift away from natural catastrophe and towards casualty risks, Swiss Re’s greatest exposure is still U.S. hurricanes and tropical storms, with its maximum exposure calculated to be around $4 billion. This exposure is down on previous years, but shows that no matter what Swiss Re does it will still be carrying a significant amount of exposure in the most competitive reinsurance market for some time, as it cannot hope to replace this business quickly.

Analysts are blaming the earnings miss on lower than expected performance in property and casualty as well as weak life and health performance. The investment returns may be one of the brightest spots, with Swiss Re explaining that it was largely the result of asset re-balancing last year. This re-balancing resulted in higher investment returns and a more diversified, but still high-quality, asset portfolio the reinsurer said.

It is a shame that no measure of the risk of the investment portfolio is provided, as it would be interesting to understand whether the asset re-balancing also included taking on an element more riskiness in the portfolio. With other reinsurers also targeting more active, and risky, investment-side strategies Swiss Re would not be alone if this was the case.

The softening of the reinsurance market only deserved a small mention, with Liès saying that the reinsurer sees the insurance market “generally softening.” Property catastrophe rates have been “softening significantly”, according to the reinsurers media presentation, driving the need to write less natural catastrophe business.

Swiss Re intends to direct more effort and capital into high-growth and emerging markets, as well as seeking to grow in casualty and profit from its life and health book, going forwards. On the investment side it intends to invest a further $3 billion of its excess capital, further underscoring its new strategy to become more balanced between the underwriting and asset side of its book.

At the same time it will continue to be selective in its underwriting of property and any catastrophe exposed business, as it seeks to avoid the impacts of the competitive market. We would expect its casualty book to grow further at the January renewals, while the catastrophe component may shrink again if conditions don’t change.

Interestingly Swiss Re did not make any mention of terms and conditions pressure in the market. With the firm writing less catastrophe business, but still having its largest exposure in the U.S. to tropical storms and hurricanes, it must have been exposed to this pressure.

With combined ration being above expectations, despite the low levels of losses, it is to be hoped that terms expansion has not been accepted at Swiss Re, as an uptick in loss experience could expose any creeping of terms. Swiss Re did disclose that its loss from European hail storms such as Ela was $100m or so.

Finally, analysts at RBC Capital Markets were not convinced about Swiss Re’s measure of risk adjusted pricing, which it said was 108%.

Whilst the company has stated that risk-adjusted price quality improved to 108% in Q214 against 107% in the first quarter, we believe that Swiss Re’s pricing has deteriorated year on year (risk-adjusted price quality was not disclosed last year). With many participants seeking to enter the casualty reinsurance market due to the more intense pricing pressure in property catastrophe business, we expect that pricing will soon come under pressure in this line.

The analysts believe that combined ratio creep will be a feature for Swiss Re in quarters to come, as it increases its focus on casualty business.

We expect that Swiss Re will continue to operate in a more opportunistic fashion than peers taking market share when prices become attractive. With falling prices in catastrophe reinsurance, impacted by non-traditional sources of capital, we expect that Swiss Re will move into casualty more meaningfully, increasing the combined ratio to 94.0% in 2015E (2013A: 83.3%).