Swiss Re has been regarded as the fast-paced player in reinsurance, but that was before the banking crisis hit. Today, its more cautious rival, Munich Re, appears to be ahead of the game.
Munich and Swiss, the two great Res, bestride the reinsurance market. Between them, they posted nearly €3bn ($4.1bn) in profits for 2009.
Big beasts they might be, but, as one leading market analyst puts it, Munich and Swiss are better represented by two smaller, less formidable animals: the tortoise and the hare.
In Aesop’s fable about the pair, the hare was well ahead in the race and disdainfully took a doze. His arrogance allowed the even-paced, hard-working tortoise to reach the finish line first. In the reinsurance market, Swiss Re’s harebrained schemes have led to similar problems compared to its sometimes lumbering, unassuming rival.
Hares are arguably more attractive, more sprightly and more nimble – and for a while, that’s how Swiss appeared against Munich. Before the subprime crisis struck in 2007, banking was the fast-paced supremo of finance.
Jacques Aigrain, once a banker at J.P. Morgan, became Swiss Re’s chief executive in 2006, a fantastic year for the financial markets, but a time that we now know to have been the boom before the bust.
ING Financial Markets insurance analyst Kevin Ryan says: “Swiss Re was go-ahead in innovation, and really became a mini-investment bank. It was the first to come up with financial instruments like the catastrophe derivative, believing that there were grey areas between investment banking and reinsurance.”
In fairness to Aigrain, his appointment was the natural conclusion to a model that had been nearly a decade in the making: it bought privately owned investment bank Fox-Pitt Kelton for $200m in 1998. But Aigrain decided to sprint, creating a major investment banking division that traded in potentially profitable, but hugely risky, financial products, which lost more than €4bn in their first full year. Typically, reinsurers stick to investing in secure but unexciting income streams, like government-backed bonds.
Financial instruments such as credit default swaps are notoriously difficult to understand and trade, so they quickly unwound as the financial markets struggled to work out who owned – and owed – what.
Plenty of businessmen and women saw the signs of a crash; the relentless property price boom was surely unsustainable as people struggled to keep up with repayments. But Aigrain’s investment banking brain seemed to make him blind to the wider picture.
This hare was so intent on its course that it failed to look to the sky to judge whether the clouds ahead would cause a storm. Its capital position became so depleted that it was forced to turn to investment legend Warren Buffett who, through his Berkshire Hathaway vehicle, took a minor stake.
Fortunately, Aigrain’s deputy, Stefan Lippe, is a veteran reinsurer and, when he replaced his former boss early last year, decided to take the group back to its roots. Former Swiss Re chairman Peter Forstmoser’s praise of Lippe damned Aigrain by implication: “His proven track record in insurance will support our efforts to focus on our core business.”
Lippe decided to stop for breath and undertake a 90-day review of the business. He de-risked the balance sheet by liquidating certain assets and businesses. For example, asset manager Conning was sold to private equity group Aquiline Capital last June. Indeed, the group has been clear that it is willing to accept losses to escape its riskier investments.
Turning a corner
After its tumultuous couple of years, Lippe brought the company back to profit. Although he insists that the
group has stayed committed to innovative products, it’s notable that these are all very much insurance-focused. For example, he mentions Swiss Re’s first “public sector longevity transaction”: protecting a UK local government pension fund should members in the funds live longer than forecast. But there are no new investments in mysterious debt packaged up by bankers.
Chastened, all ego seems to have disappeared: chief finance officer George Quinn admits that results have been boosted by the lack of natural catastrophes in 2009. “The good luck is pretty obvious,” he told analysts shortly after the results were announced last month.
Maybe a better analogy than our fable is the story of sprinter Dwain Chambers. Already a world-class athlete, he took performance-enhancing drugs to move ahead of the opposition. Post-ban, clean and occasionally overbearingly honest about his misdemeanours, Chambers has since won gold at major events such as the World and European indoor championships.
Swiss did not cheat, but it did pursue false hopes that threatened to ruin rather than secure the dream. Like Chambers, Lippe feels that a corner has been turned: “We came a long way in 2009 – and we are proud of what we have achieved.”
Imagine our tortoise and there’s Munich: a slow-moving elder statesman. But that’s also why it is the world’s biggest reinsurer. “It is the best-capitalised insurance company among the major players,” Jefferies insurance analyst James Shuck says. “There is no balance sheet risk and it mainly holds government bonds.”
Swiss’s shares are only worth about 0.8 times its book value, or its assets, whereas Munich is 1.1 times. “The only similarities between the two is the ‘Re’ in their names and that they both write reinsurance,” Shuck says.
A little harsh on Swiss maybe, but the wise old tortoise avoided any financial storm by sticking to the industry it knows best, reflected in its results last month. Though Swiss is back in the black, Munich’s 2009 profit, at nearly €2.6bn, is more than six times that – and nearly two-thirds better than the previous year.
Despite the earthquake in Chile and the destructive winter storm Xynthia, Munich chief executive Nikolaus von Bomhard feels confident enough to predict a €2bn-plus profit for this year. Once these claims have been worked through, 2011 should see a return to significant profit growth.
Play it safe
Von Bomhard’s strategy is clever: there is diversification without a complete shift from its traditional areas of expertise. For example, Munich holds a 10.2% stake in Admiral, the UK primary insurer with which it has co-operated since 2002. Even when it sold down on this investment from 15.1% last year to rebalance its equity portfolio, the group still booked a €107m profit.
Munich also has been developing the ERGO brand in Germany, where it is already the second-biggest primary insurer. The ever-cautious von Bomhard described this as “the greatest challenge and opportunity”.
There is no overselling of expectations and risk is hugely well managed, given that it has available financial resources, or a capital buffer, of €28.4bn. Munich has calculated that it only needs €17.4bn to cover its potential risks. Similarly, it has carefully balanced its bonds portfolio so that even the Greek economic crisis is likely to have only minimal impact on future results. Munich’s total capital investments are about €185bn, with barely €2bn in Greek securities.
The reinsurer is boosting its share prices by buying back stock. Since October it has spent €677m on shares and plans to have €1bn acquired by its annual general meeting this month. This is part of a broader €5bn programme announced in May 2007, a sign that the board could sense the crisis and decided to use cash reserves to protect shareholders. It also means that the dividend payout per share is far greater, and this month should even be slightly increased to €5.75. Such increases are rare in current markets, no matter the sector.
Whereas Buffett invested in Swiss as a bailout deal, analysts believe that his stake in Munich – thought to be more than 5% – reflects the strength of a business that has so comfortably navigated the economic storm. Even von Bomhard allowed himself to comment last month: “[Buffett] would not have bought in if he didn’t think our strategy good.”
This tortoise is going to come out of its shell – well, at least peek its head out a bit. With bonds paying so little, Munich is planning to invest in renewable energy assets.
These long-term purchases are more secure than complicated financial products, so von Bomhard can maintain that such a move does “not depart fundamentally from our prudent investment policy”.
Don’t expect this wise old head to reinvent itself as a playboy just yet. Munich Re has done perfectly well by having 44% of its €164bn fixed-income investment portfolio in those low-yielding government bonds, so this proportion is not going to be significantly lowered, even if it splashes out on a few new ventures.
Aesop might have written The Tortoise and The Hare more than 2,500 years ago, but it seems that Munich is still willing to pay heed to the lesson. GR
Mark Leftly is senior business reporter at the Independent on Sunday