Munich Re feels competition, but hints at capital markets opportunities

The world’s largest reinsurance firm Munich Re announced its quarterly results this morning, stating the need for continued price discipline and consistent cycle management in the competitive market environment, but that it remains on target for the year.

Munich Re has followed other reinsurers in pulling-back from underwriting reinsurance business which no longer meets its return hurdles. This includes some peak U.S. property catastrophe reinsurance where pricing has declined the most due to the high levels of excess capital among traditional reinsurers driving competition, while growing volumes of new capital enter the market from insurance-linked securities (ILS) investors such as pension funds.

CEO Nikolaus von Bomhard said he was satisfied with a quarterly result which saw the firm report a consolidated profit of €769m for the second quarter of 2014, compared to €542m a year earlier. Net income came in at €765m, which has missed on analysts expectations of around €798m, according to Bloomberg. However the technical result, which is also closely watched by analysts, was lower at €464m, compared to €620m a year earlier, as some large losses hit the reinsurer from both natural catastrophes and man-made disasters.

The combined ratio may also disappoint analysts and shareholders, coming in at 101.4% in property casualty reinsurance, driven by a major loss expenditure of €617m in the second quarter, amounting to 15.4% of net earned premiums in the second quarter.

At the same time gross premiums written in property casualty reinsurance declined 7.9% year on year to €6.6 billion, as the reinsurer kept to its word to forgo business it felt was unattractively priced. In life reinsurance, interestingly, the decline in premiums written was even higher, at 17.6% largely due to the negative impact of exchange rates. The business mix here has also changed, with Munich Re pushing more effort into writing longer-tailed casualty reinsurance premiums, as other major reinsurers have..

Von Bomhard said that Munich Re continues to follow a strategy of price discipline and consistent cycle management, which he said are imperative in the present competitive reinsurance market environment. Alongside this, Munich Re has continued to develop individually structured coverage concepts for large cedents, finding that pricing for customised, large risk solutions are a more profitable opportunity right now.

Von Bomhard’s commented; “We are choosing to forgo volume in those classes of business and regions where keen competition over prices, terms and conditions has had a particularly severe impact. At the same time, we are expanding our business with customised solutions. Our shareholders can rest assured that we are managing their investment responsibly.”

After the recent renewals Munich Re remains well-positioned, despite having pulled-back further on some lines. Von Bomhard said; “Thanks to our strict cycle management, our portfolio remains profitable even after the recent renewal rounds.”

The reinsurers investment result was good, with investment gains helping to drive the consolidated profit, despite the disappointing technical result. However, von Bomhard stressed; “Our strategy remains geared to making profits through our underwriting business, not through risky investments.” Yesterday, Swiss Re’s results detailed a more drastic move on the asset side of the business, as it shifted its portfolio in a search for improved investment returns to offset declining underwriting income.

Natural catastrophe losses cost Munich Re €291m during the quarter, with the most expensive being the Japanese snowstorms, at €180m,  with claims being booked late despite the cat event actually occurring in Q1. The Costa Concordia disaster continues to impact Munich Re as well, with the claims burden now thought to be around €120m, up on its last estimate of €100m.

Now, onto the more interesting part of the results, the discussion of market conditions and opportunities presented in a letter to shareholders.

Von Bomhard begins by recognising the entry of increasingly large amounts of new capital into the reinsurance market, writing; “The abundant liquidity made available by the central banks has also made its way into the reinsurance market. As a result, we observed fiercer competition between established market players in the first half of 2014, while pension funds and hedge funds are increasingly also breaking into the market.”

With supply still exceeding demand, recent renewals have seen steep price declines and increasing pressure on terms and conditions, wrote von Bomhard. But this must come to an end, as cycles do, he explained, adding that at some point insurers and reinsurers will have to shoulder their underwriting responsibilities, perhaps hinting that terms expansion may come back to bite some.

Von Bomhard said he is “astounded” by how many companies are pursuing growth strategies in the current market environment. Munich Re has been contracting steadily the business it writes and trying to replace it with better priced, more customised business where the competition for renewal will be much less fierce. He noted that the end result for some who have been accepting inadequate pricing for risks could be enormous losses.

Munich Re is shifting its capacity away from competitive property catastrophe reinsurance, more into casualty and the structured, customised, large account solutions. Areas which are not so dominated by “imprudent competition”, said von Bomhard.

Interestingly, von Bomhard hints at the importance of the capital markets, something which most other reinsurance firms have been keeping quiet on, preferring to blame them for competition. Von Bomhard explained that mobilising the capital markets could help to increase insurance penetration, where risks are often inadequately covered.

He wrote; “Traditional property and liability risks are also often inadequately insured, not only in the industrial regions of emerging markets, but even in established economies. What at first glance appears to be a more than sufficient supply of capacity often turns out to be far from sufficient for coverage. As such, increased mobilisation of the capital markets offers interesting opportunities for the insurance industry at the interface between risk assessment and risk diversification.”

Munich Re has been much quieter than other large reinsurers in trying to put the blame for price declines on capital markets and ILS players. Here it is clearly setting out its stall, that the capital markets continue to provide a valuable opportunity, even for large reinsurers with their own balance-sheet.

On pricing, Munich Re notes that the high levels of traditional reinsurance capital, combined with the growing interest of capital market investors such as pension funds in accessing reinsurance returns, has led to an erosion of profit at treaty renewals.

It is too early, the reinsurer says, to understand where the first signs of a pricing floor being reached particularly in ILS transaction pricing is a sign of “sustainable consolidation of the reinsurance markets.”

But, if pricing moves further south in any significant way at future renewals, the reinsurer warns that it could withdraw from an even more substantial volume of business.

The results for Munich Re show a disciplined approach to remaining on track for its full year target of €3 billion. The focus on customised solutions could actually position Munich Re very well for any market turn, as this more difficult to structure and price business should see less competition at renewal time.

Should some of the lines where Munich Re has been relinquishing business improve in terms of prospects and pricing, allowing the reinsurer to re-enter that market in earnest, it could position the firm very well for profiting once current reinsurance market conditions settle.