With rates now falling, what can reinsurers do to keep investors interested after they have banked their share of this year’s profits? Lindsey Rogerson finds out.
If profit predictions prove correct when full year figures are released, then another bumper year for reinsurers seems on the cards. These are indeed halcyon days for reinsurers. Hiscox says it expects its results for 2007 to be even better than those of 2006. Amlin said much the same in its most recent trading update, while Catlin expects a good year in the benign claims environment.
The messages emanating from Continental Europe were no less cheery: Munich Re says it is on target for a record year and expects to turn a profit of €3.9bn. Hannover Re says it is on course to beat its profit targets and even Swiss Re CEO Jacques Aigrain says the reinsurer looks set for a successful year despite its $1bn writedown.
Great times, clearly. But going forward it will be harder to pull the proverbial rabbit out of the hat. Scaremongering over the likelihood of catastrophes helped to keep rates up at renewals in 1 January 2007, but this time round the same trick came up short.
They did try their best. “The trend in respect of weather extremes shows that climate change is already taking effect and that more such extremes are to be expected in the future. We should not be misled by the absence of megacatastrophes in 2007,” warned Dr Torsten Jeworrek, board member at Munich Re. “All the facts indicate that losses caused by weather-related natural catastrophes will continue to rise.” Indeed, the group produced the figures showing that the number of insurable events jumped 12% to 950 in 2007 – the largest number since Munich Re began keeping score in 1974 (see table on page 34).
Grahame Chilton, chief executive at broker group Benfield also tried to talk up the escalation of event occurrence. “Catastrophe models suggest that the longer term escalation in size and frequency of catastrophe losses is set to continue, driven by growing risk concentrations as well as climate change,” he said.
For the most part, cedants appear to have ignored such warnings and opted to force rates down instead. Benfield’s review of 2008 renewals concludes that “remaining post-loss caution from previous years was rapidly dwindling.” Dwindling is perhaps an understatement as the report goes on to cite evidence that property casualty rates have slumped by 10%. Guy Carpenter’s research puts rates down by 9%, so quite a drop-off by either assessment.
“Analysts believe investors can expect to see a step up in buyback activity and a continuation of policies to push up dividends
A few months ago, when the credit crunch first hit, commentators had speculated that a lack of credit might lead to a welcome reduction in overall capacity, with the knock-on affect of holding rates up. As Benfield reports, no evidence of such a reduction in capacity has materialised.
Quite the opposite in fact as primary insurers are finding an increase in non-traditional options when it comes to protecting their books. The report said: “Buyer appetite for sophisticated alternatives to conventional reinsurance continues to evolve and shows little sign of being reduced by cheaper traditional reinsurance.” If this is the case then traditional reinsurers face the double whammy of softening rates and increased competition as hedge funds, private equity firms and other investors increasingly turn their attention to the sector.
Indeed, the appetite of capital market investors showed no sign of abating as the fourth quarter issuances of cat bonds hit the market. For insurers and reinsurers, non-traditional reinsurance capacity has become an accepted and increasingly popular means of diversifying risk. 2007 was a record year in terms of catastrophe bonds, with issues frequently oversubscribed. Guy Carpenter believes that 2008 will witness a similar outstripping of demand over supply.
Buybacks and dividends
Given the ready availability of alternatives, analysts believe investors can expect to see a step up in buyback activity and a continuation of policies to push up dividends. According to Guy Carpenter, reinsurers returned $9.4bn to shareholders in 2007, an increase of nearly 200% on 2006. It believes the return of capital is the direct result of excesses caused by the soft market, and that more of the same lies ahead in 2008.
“Primary insurers are finding an increase in non-traditional options when it comes to protecting their books
Despite being highly critical of the lack of information emanating from Swiss Re, James Quinn, an analyst with Citigroup says he expects to see an acceleration in reinsurers’ buyback plans. He feels that Swiss Re would have little difficulty returning £1.65bn (CHF3.6bn) to shareholders, possibly as early as December 2008.
His fellow analyst Trevor May picked out a similar method of keeping shareholders happy over at Hiscox, which is a quarter of the way through a £50m buyback programme and has also hiked its dividend by 4.6%. The dividend decision is an important one for investors, explains May, as it bumps the stock further into the realms of an income play. “Hiscox now uses its dividend payout as an active form of capital management on top of its share repurchase programme,” he says. “For 2007 it has indicated that it will pay a full year dividend of 12p – a 20% increase on the previous year. At this level, the prospective yield is 4.6% – by no means the highest in the sector but still a healthy premium to the market and surely a source of some support to the shares.”
If the credit crunch-induced market turmoil continues, investment theory suggests that income generating stocks will be increasingly in vogue as share price growth dissipates. May’s assessment of Hiscox as now two distinct businesses (see chart) also raises one further possibility for the group in 2008.
The insurance sector is expected to become a hotbed of M&A activity in 2008. The past year has already seen an increase in acquisition activity, especially that originating in Bermuda and Lloyd’s. The conservative nature of reinsurers’ investment sheets (most are viewed unlikely to be hiding subprime losses) coupled with a glut of excess capital (on the back of 2007 benign losses, and softening rates) means that many reinsurers could well find themselves the focus of M&A activity, whether they want to be or not.
Talk of takeovers does funny things to share prices, so if the analysts are right and the M&A boys do take an interest, shareholders can expect a bumpy ride in 2008, regardless of whether a catastrophe strikes.
Lindsey Rogerson is a freelance journalist.