Global reinsurance player Munich Re has reported lower returns on capital and on equity for 2015, although profit remained stable, perhaps giving a glimpse into a new normal for the large reinsurers as returns are squeezed by price pressures and competition.
Often the ability to meet or generate a profit is all that reporters and shareholders care about, but looking beyond the ability to generate financial gain, above tax and expenses, can give us a better picture of the state of an industry, especially one as in-flux as reinsurance.
For Munich Re 2015 has resulted in a healthy profit, albeit roughly flat with the 2014 figure. But start to look at the key metrics that the reinsurer uses to measure success and you can see that things are not as easy as they used to be, even for the world’s largest reinsurance firms.
Munich Re’s results reflected the reinsurance market pricing environment in 2015, with the gross premiums underwritten across the group remaining relatively stable at €50.4 billion (compared to 48.8bn in 2014) but the returns generated from this business have declined.
The firm reported its return on risk-adjusted capital (RORAC), which it uses as the key performance indicator for the re/insurance Group as a whole, as 11.5% for 2015 (down almost 2% from 13.2% in 2014), whilst the firms return on equity (RoE) was 10.0% (down from 11.3% a year earlier).
In Q4 2015 Munich Re’s returns declined again, with annualised RORAC coming in at 10.8% (down from 12.2% in Q4 2014) and the reinsurers RoE fell below 10% again, coming in at 9.6% (compared to 9.8% a year earlier).
Now this isn’t a sign of any serious issues in the business, it’s merely a reflection of the fact that profitability per unit of risk underwritten is down, in line with pricing declines. The return on risk adjusted capital is a useful metric, as it also reflects the risk assumed to a degree. So taking on slightly more risk, in terms of volume of premiums, and generating almost 2% less risk adjusted return across the business.
The lower returns are a reflection of the fact that Munich Re, as with every other company in the sector, is being paid less per unit of risk assumed in many cases. With prices down, terms and conditions expanded, more risk is assumed for underwriting capital deployed while lower returns are generated.
If the reinsurance market is truly facing a new normal of a structurally lower return environment, is this a sign of where companies like Munich Re should expect those returns to be?
And if returns are lower, perhaps with further to decline as the true impact of prior year price declines flows through, while we remain in an environment where the large loss experience has been more benign than the long-term average would suggest, what does that suggest for returns when losses revert to the mean?
Munich Re’s results are strong and analysts clearly impressed, judging by the reports flooding our inboxes here at Artemis. The reinsurer remains one of the best insulated from the wider market environment, given its scale, reach, levels of expertise, ability to lead and create new opportunities and significant reputation.
But market effects are clearly showing, which will result in the largest re/insurers continuing to focus on innovation, identifying new opportunities, growing their large corporate risk businesses and expanding their primary arms.
For the year Munich Re has reported a consolidated result that almost matched 2014, at €3.1 billion (compared to €3.2bn in 2014). Q4 2015 profit was aligned with the prior year period, at €0.7 billion.
Demonstrating that capital remains in excess Munich Re has announced a “much higher” dividend for 2015, keeping shareholders and analysts happy.
CFO Jörg Schneider acknowledged that market conditions aren’t easy though; “Due to the fact that the market environment is so challenging, the 2015 result is pleasing. Even though we benefited from random effects in the form of a low impact from major losses, the good result is mainly due to our operational profitability and rock-solid balance sheet.”
In reinsurance the firms track record for conservative reserving was evident, with large releases from prior year loss events amounting to around 8.2% of the reported combined ratio. In Q4 reserve releases amounted to 20.9%.
The combined ratios meanwhile, in property casualty reinsurance, were 89.7% for the year and 78.6% for Q4, both down on last year, but the percentages recovered from the reserve releases remain important despite the lower loss environment.
Major losses cost the company around €1 billion in 2015, with €200m in the fourth-quarter. Munich Re’s largest catastrophe loss event of the year was heavy rainfall in Chile which cost €47m. The Chile earthquake also cost the firm €45m in losses. At €897m man-made losses were up on the level seen in 2014, which is equivalent to 5.3% (3.9%) of net earned premiums. The Tianjin port explosion in China cost €175m and the dam failure in Brazil €156m, which were the two largest individual man-made losses of the year.
Munich Re has also reported on its renewal portfolio underwritten at January 1st 2016 this morning, with the company saying that “the market environment was nearly unchanged compared with the previous year.”
“There was sufficient capacity in all classes of reinsurance business. Prices remained under pressure, but to a slightly lesser degree than in previous years. Treaty terms and conditions were largely unchanged, as was the demand for reinsurance cover,” the firm explained, echoing other opinions that pricing is beginning to stabilise, at least in some regions and lines of business.
Torsten Jeworrek, member of Munich Re’s Board of Management responsible for reinsurance, commented; “We can be satisfied with the figures for the January renewals. Despite a continuing difficult market environment, Munich Re was able to seize attractive business opportunities. We are a preferred partner for clients that place value on sophisticated insurance solutions.
“Our clients appreciate the value added that we offer them. In Europe and South America in particular, we were able to conclude some treaties individually, which meant that these transactions were only subject to the intensely competitive environment in standard business to a limited extent. For some clients, we developed bespoke capital-relief reinsurance solutions – such as where there were short-term capital requirements following an acquisition.”
At the January renewal over half of Munich Re’s non-life reinsurance business came up for renewal, representing premium of around €9.1 billion. Of this, 11% was not renewed, the reinsurer said, but new business amounting to around €1.2 billion was underwritten.
In total Munich Re reported that it underwrote 0.7% more business at 1/1 2016, amounting to €9.2 billion. Across the portfolio the reinsurer reported pricing down by just 1%.
Just 1% is not a large price decline at all, however we have to return to returns at this point. A further 1% off the return on risk adjusted capital and return on equity would see RORAC at just 10.5% and RoE at 9% in 2016.
Hence, while writing a little more business at slightly lower prices, it is also vital that Munich Re and other large reinsurance firms can extract more of the profit from that business as well.
This is why efficiency is key, expense management vital and leveraging the right balance-sheet for the right risks, as in owned balance-sheet backed by shareholder capital or third-party backed by investors, can only become an increasingly important trait for a large insurer or reinsurer.
With available pricing down, resulting in lower profitability per unit of risk underwritten, which equals a lower return, the only way to recoup some of that return is to extract more of the profit from your underwriting.
This is why the disruption in reinsurance may only just have begun. While new and alternative capital has applied pressure, demonstrated the importance of efficiency and highlighted the benefits of a mixed balance-sheet approach, there are other areas of the market where percentage points of profit can be recovered.
Gaining more direct access to risk, disintermediating the intermediaries or taking other fees out of the transaction, originating and structuring your own deals resulting in closer client cultivation, leveraging third-party capital for business that needs a lower cost-of-capital, while using your balance-sheet where it is profitable. All vital traits of a successful reinsurer in the future.
Munich Re is among the strongest, but the results show that no company is immune from market pressures, especially in a market that has been undergoing fundamental change and which likely has significantly more change to undergo in years to come.
The returns reflect the depressed state of reinsurance pricing. The question is whether lower for longer is the new normal in reinsurance and how companies which don’t have the luxury of Munich Re’s scale and diversification will cope over the longer-term?