Munich Re results reflect lower profitability of underwriting

Another major reinsurer reported its results this morning and Munich Re’s figures, much like its competitors, clearly reflect the fact that the profitability of underwriting has been eroded by the soft market, resulting in lower returns and a continued need to pull-back on the most challenging areas of the reinsurance market.

Munich Re’s results showed a decline in profit for the quarter, as reported in more detail over on our other publication this morning, with returns on the wane despite a much lower quarterly loss burden.

The results once again reflect a company navigating a challenging reinsurance market environment, fighting competition and maintaining discipline where necessary.

But the underlying effect of this and the generally lower pricing available in the marketplace is an erosion of profits and lower returns.

For the second-quarter of 2017 Munich Re reported €733 million of profit, down from €974 million in Q2 2016, while for the first-half €1.290 billion of profit is well down on the €1.411 billion reported last year.

But in the reinsurance business a €629 million contribution to Munich Re’s consolidated result, down from €991 million in the prior year, reflects an even steeper drop in profitability.

That is despite the reinsurance combined ratio coming in at 93.9%, significantly lower than the 99.8% reported for Q2 2016.

Across the Munich Re business returns are down as the effects of this environment, where underwriting a similarly sized book of business with a lower combined ratio can still result in generally lower profitability, flow through to affect returns on equity.

RoE for the second-quarter came in at 9.4%, down considerably on Q2 2016’s 12.2%. While Munich Re’s favoured metric of return on risk-adjusted capital (RORAC) came in at just 11%, down from 16.5% in the prior year.

With a much lower combined ratio, lower loss experience, lower tax burden, all with a portfolio of risk of a similar size to prior years, the profitability is clearly diminishing, making disciple increasingly important.

Munich Re has pulled-back considerably in its property and casualty reinsurance underwriting, with a -8% shrinking of premiums written for the quarter, resulting in an overall contraction of reinsurance unit premiums of -2.1% (it grew in life and health).

Of course the pull-back is expected and in many ways the only sensible response to make, alongside the shift in business mix as more life and health reinsurance is underwritten and the focus continues to shift to sourcing risk at the primary end of the value-chain through ERGO.

The fact lower profitability is evident is a reflection of market conditions and actually the major reinsurers, like Munich Re and its competitors are about the best positioned to navigate the market more effectively at this time.

But like its cohort of the largest reinsurers in the world the sustained pressure of lower pricing has eaten away at overall profitability, particularly of the reinsurance side of the business. The repeated years of shrinking that side of the business could eventually have the effect of making it a less important lever of their profit though, which over the longer-term could be viewed as a positive as the big reinsurers add more diversification to their income sources.

Pressure is evident on the property and casualty reinsurance book, especially so as the loss experience has been much lower than forecast. This does suggest that even the biggest reinsurers are becoming more exposed to a major shock, should loss activity pick up significantly or something like a deterioration of casualty reinsurance performance occur.

By this we mean a shock that would impact the entire market, but would now become much more evident and more quickly in the results of the major reinsurers. Underwriting at lower returns and broader terms and conditions for consecutive years does suggest a higher level of exposure assumed and with returns and profits diminished it wouldn’t take nearly as much to tip into negative territory, compared to what it would have taken a few years back.

That’s the other effect of a soft market, despite the discipline there is always going to be more risk per unit of income assumed due to the general trend to give more coverage away for less.

Reinsurers, even those as big as Munich Re, have to keep their fingers crossed to a degree, as should a market event occur there could be a difficult time ahead.

Of course they’ll be hoping for a rebounding of the cycle, to recoup that all important “pay-back”. But if that doesn’t happen and the capital continues to flow to the alternative and ILS market, the pressure on reinsurers to think again about underwriting large areas of catastrophe risk could also rise.

But Munich Re has beaten analysts expectations in its results today, helped by the lower than expected loss incidence and it shouldn’t be understated that the major players are clearly adapting to the market conditions we see today and that their scale can help them to continue to navigate it successfully.

But, the soft market is clearly evident in reinsurers results, who despite their pulling-back and shifting of business mix, continue to experience declining returns and profits, while the level of risk assumed (per unit of capacity deployed) is likely higher than before. The pain is becoming increasingly real.

Also read our take on Swiss Re’s results here.