Munich Re: Reinsurance market competitive as capital spills over

The world’s largest reinsurance firm, Munich Re, expects conditions in the global reinsurance market will remain competitive in 2014. It also acknowledges the spreading influence of alternative capital as it spills outside of pure catastrophe business.

Munich Re’s profit target for 2014 is €3 billion, down on the €3.3 billion the firm achieved in 2013. That result in 2013 was the third best annual profit in Munich Re’s history, but challenges in the market and economy in 2014 make it unlikely to be repeated.

CEO of Munich Re Nikolaus von Bomhard commented on the firms 2013 performance; “The result for 2013 is an indication of how we have positioned ourselves competitively – we have strategically prepared Munich Re for foreseeable challenges which we can now tackle from a position of strength.”

The challenges Munich Re feels it faces in the coming years, which it believes it is well positioned to deal with, include the continued low-interest-rate environment which makes asset side performance more difficult, the increasing competition in the global reinsurance market driven by new entrants, capital markets capacity and well-capitalised traditional reinsurer competitors as well as changing demand on the primary insurance side of its business.

von Bomhard explained why the firm feels well-placed to deal with these challenges; “We have done our homework in recent years. Our capital base is more than solid, in reinsurance we are committed to solution-finding competence, and in primary insurance we are bringing a visionary concept to the German market with our new generation of life insurance products.”

It is no surprise to see that Munich Re is returning even more capital to its shareholders, with the announcement this morning of another share buyback which could total as much as €1 billion over the coming year. That equates to approximately 3.7% of the reinsurers share capital, again showing that while reinsurers have been profiting they are not currently able to take advantage of this by putting excess capital to work.

Rather than sit on excess capital, or put it to work in mergers and acquisitions, reinsurers have tended to return unused capital to shareholders over the last couple of years. It’s a sign that opportunities to deploy excess capacity while maintaining return on equity are more scarce than in previous years.

There is also an element to the raft of share buybacks and increased dividends (Munich Re also announced an increased dividend this morning) which involves reinsurers returning capital rather than deploying it into the reinsurance market and exacerbating price pressure through the increased capacity.

If reinsurers had forced more capital into the market, creating premiums by offering it at increasingly competitive prices, they would effectively be increasing the pressure they’ve been feeling from the influence of alternative capital and lower their RoE’s further.

“With this share buy-back, we are again paying out currently unneeded earned capital to shareholders,” explained von Bomhard. “Our good capitalisation enables us to continue taking selective advantage of opportunities for profitable growth in individual regions and classes of business. At the same time, it supports the discipline which is so important to us when underwriting risks.”

In 2013 Munich Re underwrote slightly less premiums in its reinsurance business, but puts this down to exchange rates saying that if rates had remained the same its premium volume would have increased by 3.1%.

Lower than expected levels of natural catastrophe losses helped Munich Re in its reinsurance segment, suffering €764m of natural catastrophe losses and €925m of man-made losses during the year. The firms largest catastrophe losses were the floods in central Europe in June (€178m) and the intense rain and hailstorms in Germany in June and July (€174m)

Munich Re, like the other large reinsurers, is pushing its diverse book and ability to create customised solutions in reinsurance very hard in recent months, as it seeks to differentiate itself from the ILS and alternative reinsurance capital which it sees as targeting more commoditised layers of reinsurance.

Torsten Jeworrek, Munich Re’s CEO of reinsurance, explained; “As a well diversified reinsurer with extensive know-how, we are in a position to offer tailor-made solutions. Moreover, with our technical expertise and risk knowledge, we are able to support rapidly growing industries and to judiciously extend the boundaries of insurability with needs-based covers.”

Munich Re expects the reinsurance market will remain competitive through 2014, particularly if there are no major loss events. At the upcoming April 1st and mid-year renewals Munich Re expects to renew reinsurance treaty business with premium volumes of around €3.2 billion but with a greater share of natural catastrophe reinsurance than it renewed in January.

While it expects continued pressure on its reinsurance renewals, with pricing likely to see further declines as alternative capital and well-capitalised traditional players continue to broaden their reach, Munich Re expects to be able to minimise any impact to its profits.

Jeworrek explained; “Given our strong position on the market, we expect to be able to limit the effects on our own portfolio.”

Interestingly Munich Re expects a higher combined ratio for its property-casualty reinsurance segment, in 2013 it achieved a combined ratio of 92.1% but says that for 2014 it expects to achieve 94%. This could suggest that the reinsurer is taking on a little more risk at the renewals, perhaps with slightly relaxed terms or as it targets more customised solutions, however that is just speculation and the firm offers no reasoning for the higher ratio.

Munich Re acknowledges that the pressure on reinsurance pricing, caused by the influx of alternative capital from investors and the increased capital base of traditional reinsurers, is now spreading outside of pure property catastrophe reinsurance business. Munich Re said that it is now seeing the spillover effect of this capital moving into other segments of the global reinsurance market.

As alternative reinsurance capital, insurance linked securities and other alternative reinsurance strategies grow in size and maturity this spillover effect is likely to accelerate. There is going to be an increasing amount of new capital finding its way into more niche areas of reinsurance and while this may be a slow process it is going to impact on globally diverse reinsurers like Munich Re.

One area that Munich Re has tried to protect itself from the influence of capital markets players and its well-capitalised traditional competition is in underwriting more reinsurance business which is not connected to the typical renewal cycle. By targeting customised solutions and growing its share of business which is decoupled from the renewals it helps it to avoid some of the most competitive areas of the market.

Munich Re continues to take advantage of alternative reinsurance capital as well, both for its own retrocessional reinsurance protection and in delivering services to clients to gain fee income by enabling them to access the capital markets capacity. The focus on acting as a transformer or fronting reinsurer is likely to continue at Munich Re as its competitors increasingly begin to target this business as well.

In 2013 Munich Re worked on ILS transactions for third-parties totalling $1.2 billion, compared to $600m in 2012 and just $200m in 2011. It intends to continue to focus on ways to structure and facilitate access to third-party reinsurance capital for its clients while also building on collateralized Munich Re capacity, such as through its Eden Re sidecar vehicle.

Munich Re notes that the influence of alternative reinsurance capital remains strongest in the U.S. market, adding that it saw little influence from it in Asia and Australia in January. However, it is not just the direct influence of ILS and the capital markets that matters, although that is growing and will continue to expand.

Rather it is the indirect influence, as alternative capital increases its hold on areas of the U.S. and global catastrophe reinsurance space, forcing other reinsurers to look elsewhere and growing the competition for business in other regions. Combine that with a slow expansion of alternative capital into other lines and the pressure on traditional players does not look likely to reduce in the near future.

This is why the April reinsurance renewals could provide another example of the widening influence of alternative capital, if not directly then on an indirect basis.

For Munich Re and other globally diverse reinsurance firms, the direct impact from the changing reinsurance market, increasing volumes of alternative capital and the use of capital markets instruments such as ILS, is so far not a major concern. It is the smaller, catastrophe focused reinsurers, particularly those which have not yet fully embraced alternative capital themselves, who will feel the squeeze first.

But as the trend continues and more alternative capital is deployed into the reinsurance market the impact on reinsurers like Munich Re could grow. As ever, it is how the market reacts after a major loss event that will be most telling. If alternative capital floods into the reinsurance market en-mass after an event, even firms the size of Munich Re may find the pressure on them increasing significantly.