Swiss Re Insurance-Linked Fund Management

Xactanalysis Insights and PCS

Reinsurers: Impact of alternative capital moderate, not fundamental


As the world’s largest reinsurers announce third-quarter results, which saw both Munich Re and Swiss Re’s Q3 net profits fall, the two global reinsurers stated that the impact of insurance-linked securities (ILS) on their business was ‘only moderate’ and ‘not fundamental’.

The market has not been so kind to the large reinsurers, with a number of factors impacting results including a number of loss events, the financial climate impacting investment results and a highly competitive reinsurance market due to high levels of traditional and non-traditional reinsurance capital.

The results of two of the big reinsurers, Munich Re and Swiss Re, show the challenges they face as both have seen sharp declines in net profit for the quarter. For Swiss Re the sale of a U.S. business made much of the difference but it has also seen declines in profit from its property and casualty business.

Munich Re saw Q3 net profit fall by 44% from €1.136 billion in 2012, to €636m in Q3 2013. For the first nine months Munich Re has also seen a decline in net profit, from €2.73 billion in 2012 down by 21% to €2.158 billion for the first nine months of 2013. Earnings per share, return on investment and return on equity are all down for Munich Re, painting a picture of a difficult time to run a big reinsurer.

It’s important to note the negative impacts Munich Re has faced; losses across its property-casualty primary insurance and reinsurance business, increased expenditure in life reinsurance in Australia and the USA, a loss on the disposal of the Windsor Health Group, poor performance of derivative financial instruments, and significant negative currency effects.

Swiss Re saw profit in its largest P&C business drop to €807m in the third-quarter from over a billion the year before. Premiums were up however but clearly did not translate into profits the same way as a year earlier. Across its whole business Swiss Re’s profit dropped to €1.1 billion in Q3 from €2.2 billion the year before, although much of that decline is due to the sale of U.S. Admin Re business.

Timing is bad though, as the world’s largest reinsurance firms are all coming to terms with a new market dynamic as third-party capital and ILS specialists begin to eat into areas of the business that were once core to them. Of course the scale of a Munich Re or Swiss Re means they can adapt and target new areas where ILS and alternative capital are not having such a marked effect, but it all adds up to extra pressure at a time when the market is not as easy to profit due to competition from well-capitalised traditional reinsurance players.

Both Munich Re and Swiss Re have put a concerted focus on the issues of expanding reinsurance coverage to new regions and the developing world in recent months, which must partly be to build opportunities where they feel their scale can help to build opportunity and secure market share before the influence of smaller reinsurers and ILS capital move in.

Munich Re’s Chairman’s letter to shareholders today focuses solely on this issue, showing that expansion of the market is a key focus. This is a good thing for all participants in the market as where large reinsurers go the rest of the market will eventually follow, including ILS and alternative capital, so Munich Re and Swiss Re’s efforts in this area create opportunity for all.

Both of the reinsurers had comments to make about alternative reinsurance capital and insurance-linked securities (ILS) in their results statements and reports. Both seem keen to continue to play down any impact, which of course we know can be negligible in terms of actual business directly lost, due to their ability to expand, but the knock-on effect across the sector is perhaps large enough to begin to make these large reinsurers a little more nervous.

Munich Re said that the reinsurance market remains competitive and that ILS covering catastrophe risks are increasingly being favoured by institutional investors such as pension funds as they search for reasonable returns.

Torsten Jeworrek, Munich Re’s Reinsurance CEO, stated; “We are only moderately affected by this development because capital is mainly being channelled into non-proportional catastrophe business. Our portfolio, however, is broadly diversified with different lines of business, a high share of proportional business, and our specialised units for industrial and major corporate risks.”

Munich Re clearly feels the influence of ILS is large enough to need to defend itself, highlighting the differentiation that a large, global reinsurer offers, perhaps an interesting PR response as many industries would avoid commenting. Jeworrek continued; “Besides, we offer our clients much more than just capacity. This is demonstrated especially by our solutions for complex risks and by individual coverage concepts for our clients.”

Munich Re said that the fact that ILS and alternative reinsurance capital is largely being channelled into non-proportional reinsurance business means that it can avoid much of the impact, as its portfolio is two-thirds focused on proportional property reinsurance business.

Swiss Re also recognises the influence of alternative capital and ILS on its reinsurance business. Its letter to shareholders, from the Chairman and Group CEO, says that alternative capital is increasing competition and capacity in reinsurance, but to date is focusing on peak U.S. natural catastrophe risk business.

Swiss Re felt it important to point out that the current wave of alternative capital has not faced major losses, although you could say Tohoku, Sandy, U.S. tornadoes, the Thai floods, German floods and German hail events this year, which all impacted some alternative capital, might count. The letter to shareholders notes; ” However, it has yet to be tested in the case of rising interest rates or large catastrophe losses.”

Like Munich Re, Swiss Re does not believe the impact of alternative capital is meaningful to its business. The letter says; “We firmly believe that alternative capital will not fundamentally challenge Swiss Re’s business model.” It goes on to say that Swiss Re’s scale, knowledge and client partnerships position it to continue to profit through creation of value.

So, two of the largest reinsurance groups in the world believe that the impact of alternative reinsurance capital and ILS on their respective business is ‘only moderate’ and ‘not fundamental’. The fact that Munich Re and Swiss Re feel the need to comment does make the impact likely meaningful, but given their scale and expertise these large reinsurers will adapt and also find ways to leverage alternative capital and ILS for their own needs.

It is again testament to the continued growth, increase in profile and success of the ILS space that it is felt necessary to reiterate its lack of impact to shareholders. The shareholders of these large reinsurers will be all to aware of ILS and alternative reinsurance capital and by making statements on its moderate, or not fundamental, impact these reinsurers will ward off questions at their investor days and presentations.

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