Munich Re continues to pursue profitability over growth, discovers Nick Thorpe, despite losing its stronghold as the world's largest reinsurer.

Munich Re surprised everyone with the release of its 2005 results in March with a healthy, on-target profit of over EUR2.7bn (an increase on 2004's figure of EUR1.89bn). And yet its combined ratio was up considerably to 110.5% from the previous year's figure of 98.9%. Despite this, Nikolaus von Bomhard, Munich Re CEO, was optimistic: "We have slightly exceeded our target this year. Our solid basic business makes the achieved level of profitability sustainable," he said.

Despite a record year for hurricanes, including the most powerful and costliest storms ever recorded, the group still posted a reinsurance profit of EUR1.4bn (down from 2004's figure of EUR1.7bn). Operating result before tax and finance costs was EUR2.4bn, down from EUR2.6bn in 2004, despite the group's massive hurricane loss (EUR2.3bn after retrocession) and the reserve strengthening of American Re (now Munich Re America) of EUR388m before tax following relief of EUR906m from incurred but not reported reserves.

The group continued to surprise analysts by announcing a record dividend payout totalling EUR707m in 2005. It cited the successful renewal periods earlier in the year as one of the reasons behind this generosity, particularly renewals in Japan and Korea, and pointing to underwriting discipline in this arena. "Although the high hurricane losses put us to the test last year, thanks to our broad diversification with significant operations in primary insurance and reinsurance, we were able to more than just compensate for the burdens", said von Bomhard in his report to shareholders.

Profits grew in Asia in 2005, particularly in China, Taiwan and Hong Kong, with premium income rising by EUR299m to EUR499m. This was followed by the organisation's recent affirmation of further portfolio expansions throughout Asia. In life and health, premium rose to EUR7.8bn (compared to EUR7.5bn in 2004) with high-profitability business, whereas in property-casualty reinsurance it decreased by 2.1% to EUR14.5bn. Von Bomhard singled out the global health market as one that offered substantial growth and earnings opportunities. "Growth is not an end in itself. Smart growth means seeking profitability and growth potentials off the beaten track as well. Here the global health market offers us great opportunities."

Profit, profit, profit

Munich Re is one of the world's oldest and largest reinsurers, operating in over 160 countries and offering both insurance and asset management alongside its core reinsurance business. The group is highly diversified, both geographically and in terms of lines of business. Of the EUR38.1bn of premiums written in 2005, more than EUR22.3bn or 59% of gross written premiums were from reinsurance, with primary insurance accounting for the remaining 41%. Within its reinsurance business, life and health accounts for 35%, the largest chunk of gross premiums. Geographically within reinsurance, North and Latin America are key markets (accounting for 12% each). Europe accounts for around 10%.

The primary side of Munich's business is far more jurisdiction specific. The vast majority of it is conducted within Germany, which accounted for 81% of premium income in 2005. The remaining 19% is derived from other European countries. The group comprises of the ERGO Insurance Group, Europaische Reiseversicherung and the Watkins Syndicate. Until Q4 of 2005, the group also owned a 90% stake in the Karlruher Insurance Group (which was sold in October 2005 to Wurttembergische Leben for an undisclosed sum). The primary operating result in 2005 was up 242.9% to EUR1.5bn.

The 2006 Q2 results seem to support the positive outlook offered by the company at the beginning of the year. It announced a healthy rise in half year profits to EUR2.1bn, up from EUR876m in the first half of 2005. Operating results rose by over 48% to EUR3.3bn (EUR2.2bn in 2005). Reinsurance contributed over EUR1.7bn to the group's overall profit, a 156.4% increase, and the reinsurers' investment result rose to EUR2.3bn. Favourable changes in exchange rates meant premium volume was up slightly to EUR11.3bn from EUR11.2bn in 2005. The results were especially pleasing given the struggle to recover from a difficult previous year but von Bomhard was cautiously upbeat. "We have reason to be optimistic, given business performance to date, our well-balanced portfolio, and our selective risk acceptance. Even if we are more heavily affected than in the first half of the year by major losses or by a further moderate price fall on the stock markets, our target for 2006 - a 15% return on risk-adjusted capital - is still within reach."

Strong ratings performance

In November of last year, Standard & Poor's raised the financial strength rating of Munich Re to "A+" from "A" and removed them from creditwatch. The agency also raised the credit rating of American Re (Munich Re America) to "BBB+" following Munich's recapitalisation of its subsidiary after some shaky times. At the time S&P credit analyst Laline Carvalho said, "The recapitalisation demonstrates Munich Re's strong commitment to this subsidiary and the US reinsurance market despite American Re's poor operating performance in recent years."

In June 2006 the agency affirmed its ratings but revised its outlook for Munich Re and its core subsidiaries from stable to positive. This followed some key management actions over the previous months which had enhanced the financial strength of the organisation. This included a renewed focus on integrated risk management, the full integration of American Re, the managing down of strategic asset concentrations and profitability measures at primary insurer ERGO. "The outlook revision reflected the significant progress the group had made in strengthening its underwriting, pricing, and risk-management processes," said S&P credit analyst Simon Marshall. "We consider that these improvements in management, along with the introduction of a performance culture, are permanent in nature and are a leading indicator of improved financial strength," he added.

Challenging times ahead

The 1 January 2006 renewals saw significant price hikes following a turbulent catastrophe year in 2005. The premium rate increases were mainly felt on catastrophe lines, particularly US windstorm, and slight pressure on prices for liability and industrial property business in a select few countries. Generally, all other business lines have moved sideways, particularly the non-loss affected markets. The retrocessional market remains very tight reflecting the small number of players in this arena (even less following Swiss Re's announcement that it would not continue the retrocession business of GE Insurance Solutions) and the tightening terms and conditions following last years storms. Retro has simply become unaffordable, with price hikes of up to 100% recorded at the mid-year renewals, and Munich Re currently sees no reason for this to change.

Munich identifies three main challenges in the run-up to 2007 renewals - ongoing natural catastrophes; personal injury hyperinflation; and terrorism. Large reinsurers like Munich Re are relying even more on global and business-wide diversification to decrease their potential aggregate exposure to natural catastrophes. A major buzzword at the Munich Re briefing at this year's Rendez-Vous de Septembre in Monte Carlo was "diversification", with the reinsurer pointing to Solvency II as one of the ways forward. Von Bomhard voiced his appreciation for the upcoming regulations, saying they were "good news" and would encourage a highly qualitative approach and a "greater culture of diversification".

Diversification, as von Bomhard stresses, gears up large reinsurers like Munich Re to better absorb catastrophe losses. While cat events worldwide cost Munich Re in excess of EUR2.6bn last year alone, accounting for 81% of the group's total expenditure for major losses, von Bomhard is not overly worried. "Sudden and accidental catastrophes do not keep me awake," said von Bomhard. "It is the 'creeping death' scenarios, the events that cannot be stopped overnight, that give me nightmares long into the night." But so far so good this hurricane season as the reinsurer enters October with no major hurricane losses on its books.

Pipped to the post

Much has been made of Swiss Re's leapfrogging Munich Re into the coveted position of world's largest reinsurer following its acquisition of GE Insurance Solutions. If Munich is desperate to win back that accolade it has so far remained tight-lipped. But that could be changing. When asked about potential acquisition strategies of its own at the recent press briefing von Bomhard replied: "We don't need to make any acquisitions at the moment but we will not abstain if something of the right size and price came along." But he played down speculation surrounding a possible acquisition of the troubled life reinsurer Scottish Re, maintaining that the group was "not interested in the company or their book".

- Nick Thorpe is senior reporter of Global Reinsurance.

Munich Re - takaful license

In September 2006 Munich Re revealed it was the first foreign reinsurer in Malaysia to be granted a license to establish retakaful companies. The license entitles Munich Re to offer retakaful solutions to clients independently of any joint venture and gives them access to both the general and family retakaful businesses in the domestic takaful industry. Takaful, a 1400-year old Islamic insurance concept which observes the rules and regulations of Islamic law, is one of the fastest growing areas of the industry. In Malaysia alone it has been growing at 25% annually for the last five years and the total industry assets stand at $1.7bn.

Munich Re - Nikolaus von Bomhard

Nikolaus von Bomhard joined the Munich Re graduate trainee programme in 1985, and afterwards worked as an underwriter in the operational division: fire/treaty. In 1992 he was appointed deputy head of the operational division, Germany. In 1997 von Bomhard took on the task of building up and managing the Munich Re office in Sao Paulo, Brazil. In 2000 he was appointed to the board of management and from 2001 was responsible for the Europe 2/Latin America division. He was appointed chairman of the board of management on 1 January 2004. Von Bomhard is responsible for group development, executive offices, group top executives, press and internal auditing. He is married with two children.