Adrian Leonard tracks developments at Swiss Re during the Mühlemann-Kielholz years.

It was back in 1994 that McKinsey & Co consultant Lukas Mühlemann went client-side to become Swiss Re's chief executive. His main task was to implement a `strategic reorientation' of Swiss Re by refocusing the company (nearly) exclusively on reinsurance, but his appointment was ultimately more significant.

It marked the beginning of a new era for Swiss Re and its strategic banking partner, Credit Suisse. Over the next eight years, Mr Mühlemann and Walter Kielholz, his colleague and supporter, would go on to reshape both companies according to a shared vision of the future of financial services.

In 1995 and 1996 Swiss Re posted successive 50%-plus annual net profit increases. They were attributed by Mr Mühlemann to the reorientation, which effectively comprised the sale for CHF5.5bn, of Swiss Re's primary insurance operations. The disposals, to Winterthur Swiss Insurance and Allianz, halved Swiss Re's premium income, but stemmed a flow of red ink flowing to its P&L account and gave it a massive war chest to implement the vision. Investors and board members applauded Mr Mühlemann (perhaps forgetting that Swiss Re had originally purchased and expanded its primary operations based on a McKinsey-advised diversification strategy, although in the face of such dramatic improvement, selective memory is understandable).

Inventing convergence

The innovative, trendy and under-explored theme of `convergence' lay behind Swiss Re's new reinsurance-focussed strategy, to be played out in partnership with Credit Suisse. It was the key ambition driving boardroom decision-making throughout the 1990s, and was thrown into the spotlight when, after just 17 months in the job, Mr Mühlemann announced that he would leave his post at Swiss Re to become CEO of Credit Suisse Group (a position created for him). The bank, founded in 1856 and one of Switzerland's finest, was already Swiss Re's largest shareholder, and the two companies had several joint ventures in operation, including Credit Suisse Financial Products, 20% owned by Swiss Re, and bought in 1994 with the proceeds of the insurance company sales.

Despite his onerous new job, Mr Mühlemann didn't sever his links with Swiss Re. He instead became deputy chairman of its Supervisory Board. Meanwhile Mr Kielholz became chief executive. He had joined the reinsurer in 1989, after spending three years in the multinational services department of Credit Suisse, where he had been responsible for large insurance group clients. The position of Swiss Re managing director was abolished, leaving no doubt who was in charge (although later the post was reinstated, and Mr Kielholz was appointed to that job, too).

Mr Kielholz had risen through the ranks of Swiss Re quickly, eventually landing a job running the alternative risk transfer markets division, which had three joint ventures with Credit Suisse. Reinsurance Financial Consultants, Swiss Re Financial Products and Securitas Capital Partners were convergence-focussed operations that provided an excellent training ground for a chief executive to continue to execute the new Swiss Re vision.

At the top of the hierarchy was Swiss Re chairman Ulrich Bremi, who had been in charge since 1992, when Swiss Re was plain old Sweizer Rück. Additionally, he had been a member of the group board of directors of Credit Suisse since 1989. He gave up both jobs ten years later, when he reached retirement age. Mr Kielholz, by then chief executive of Swiss Re, took up the vacant seat on the Credit Suisse board of directors, but chose not to take over as Swiss Re chairman. Instead, Swiss corporate doyen Peter Forstmoser took the chair, after nine years on the board.

Back at Credit Suisse, longstanding chairman Rainer Gut stepped down in 2000, making way for his chosen successor, Mr Mühlemann, to take the big seat (just as he had stepped down from the deputy chairmanship of the Swiss Re board of Directors in 1996, where he had sat since 1984, to make way for Mr Mühlemann's deputy chairmanship of Swiss Re). At the time, Credit Suisse proudly announced: "The group has grown from a traditional Swiss bank into a global financial services provider. It is thanks to [Mr Gut's] initiative that Credit Suisse group now enjoys a strong position in global investment banking and in bancassurance."

As at Swiss Re, primary insurance plays an important role at Credit Suisse, although the bank moved towards insurance in its pursuit of convergence, rather than away from it. In 1995 it announced a strategic bancassurance partnership with Winterthur group (buyer of much of the old Swiss Re insurance estate), in 1997 it merged with Winterthur, and in 2000 Winterthur (which Credit Suisse had a hand in founding in 1863) was integrated into the new Credit Suisse Financial Services business area. Today (for now) the chairman and vice chairman of Winterthur are none other than Messrs Mühlemann and Kielholz.

The 1995 announcement came a year after Credit Suisse had formalised its strategic alliance and cross-shareholding with Swiss Re through an announcement. A Winterthur-type marriage was out of the question, however. Swiss Re had to be seen by its European cedants to be out of the business of competing with them, and in December 1997 the pair explicitly denied any intention to merge. Yet the tie-up between reinsurer, bank and insurer was, by all measures, a success. Top decision-making authority at all three companies had been blended and placed in the hands of Messrs Mühlemann and Kielholz. Joint ventures appeared to be tapping effectively into trans-divisional expertise. Winterthur dutifully flogged its substantial reinsurance division (to PartnerRe, another Swiss Re invention) so as not to compete with Swiss Re. All three businesses were expanding at rates of knots, growing more profitable, and increasing their dividends. Convergence of the kind envisioned years before by Mr Gut was proving a success.

Then there was one

How times change. In September, Mr Mühlemann was deposed from his lofty post at Credit Suisse. Perhaps he will go back to management consultancy. It is the only experience on his Credit Suisse curriculum vitae that predates his job as chief executive of Swiss Re, but apparently it was sufficient qualification to oversee Mr Gut's vision for Switzerland's most ambitious convergence gamble. After Mr Mühlemann fell on his sword, Mr Kielholz was appointed to replace him, from 1 January 2003, as chairman of Credit Suisse. The chief executives of its two business units have stepped in to act as interim co-chief executives of the parent.

Mr Kielholz inherits one of the greatest of European financial services challenges: eating his own visionary cooking, and that of Messrs Gut and Mühlemann. Credit Suisse stock has sunk to a nine-year low. The bank's finances reached such a perilous state that it has sold off its 6.67% stake in Swiss Re. US investment bank First Boston, acquired by Credit Suisse in 1988, has delivered egregious losses, and is to shed 1,750 jobs. (The division includes the rump of US investment bank Donaldson, Lufkin & Jenrette, 71% of which Credit Suisse bought from Axa in 2000, when Claude Bébéar, architect of the leading French convergence play, saw the writing on the wall.)

Meanwhile, Winterthur has returned to its old practice of flowing red ink into the mix (although now it goes to Credit Suisse, rather than Swiss Re). This year it required a cash injection of SFr3.7bn. The bank has pledged that it will not subdivide its insurance operations for a piecemeal sale, but Winterthur has served as a handy whipping boy for the woes of Credit Suisse under the direction of Mr Mühlemann. CSFB chief executive John Mack (known on Wall Street as `Mack the Knife' because of his ability to slash budgets) is to take over as group chief executive in January, and attempt to clean up the mess.

And the good news...

Swiss Re performed differently under Messrs Mühlemann and Kielholz. From the perspective of investors, it has been a stunner. The value of its shares has increased, on average 22% per year in the decade ended in March 2002. When adjusted for the effects of a 20-for-one share split, Swiss Re's share price has soared from a 31 December value of SFr39 that year to SFr167 at year-end 2001. It was for some time even better, but much of Swiss Re's value has been lost since it peaked in excess of SFr200 per share in November 2000. This year the share fell briefly to a low of about SFr70, but since has recovered to more than SFr110. In context, Swiss Re's share price is not much out of step with European equity indices, has massively outperformed other Swiss blue chips (notably Credit Suisse, Swiss Life and Zurich Financial Services), and has outperformed the Dow Jones Europe STOXX Insurance Index in the three years to late November 2002.

Swiss Re has been changed beyond recognition since Messrs Mühlemann and Kielholz began to implement Swiss Re's strategic focus on reinsurance and the pursuit of convergence. The former included an expansion into life reinsurance, successfully achieved through the acquisition of Life Re, Lincoln Re and M&G Re. Along with numerous closed books of US life business, Swiss Re bought Royal Maccabees Life, Royal Life of New York, Southwestern Life, Security Life & Trust, and Midland Life. Each was placed in run-off under the fancy name Administrative Reinsurance. Eventually Swiss Re Life & Health was formed.

On the non-life side, Swiss Re purchased Unione Italiana di Riassicurazione (UNIORIAS), Mexico's Reaseguros Allianza, Alhermij of the Netherlands, and New York broker-carrier Underwriters Re. It boosted its investment in offspring Bermudian catastrophe reinsurer Partner Re, and through it gained a stake in France's SAFR, and later in Winterthur Re. It even bought a 9.9% stake in China Insurance International Holdings, part of what is now China Re. Subsidiaries Union Re and Bavarian Re were integrated.

Convergence agenda

While chasing life business, the duo pursued convergence with a vengeance. In addition to the many experimental ventures with Credit Suisse, Swiss Re bought investment bank Fox-Pitt Kelton, DFA specialist Falcon Asset Management and research firm Conning Corp. In January 1999 Swiss Re America launched a new division, Strategic Financial Solutions Group, to "work with clients to develop strategic, financial restructuring plans to achieve such objectives as a merger, acquisition or management buy-out". In 1998, Swiss Re Capital Partners was formed to manage the company's investments, as well as its holdings in the bank and Securitas Capital, which makes equity investments in insurance and related companies.

At new business pitches, Swiss Re client managers gave their `black box' talk, with a graphic showing all of the customers' risks, from commodities futures and interest rates to weather and supplier failure, going into one side, and a nicely smoothed earnings report coming out the other. By this time, the presentation was made not just to insurance company clients, for Swiss Re hadn't exactly stuck to its commitment to stay out of primary insurance. Corporate clients were now a major part of Swiss Re's target audience. It was happily going direct to the Fortune 500 through its alternative risk transfer markets division, formed in 1994. In 1997 it was reorganised to become Swiss Re New Markets (which, oddly, included the group's aviation reinsurance division).

New Markets' approaches to cedants' plum clients in the mid 1990s, before everyone started doing it, raised the ire of insurers everywhere. Undeterred, Swiss Re's annual report declared: "The units of the Swiss Re New Markets division offer Fortune 500 companies a broad spectrum of risk financing solutions, particularly in the area of low frequency major losses." The company argued to its cedants that New Markets was not promoted, so the business it picked up had already left traditional channels to seek triple-A security.

In a few years, all but the largest insurers realised that this territory had been permanently colonised by reinsurers, following an invasion led by Swiss Re. It was all part of Swiss Re's `three pillar' business strategy: to be masters of risk transfer in all its forms, both traditional and unconventional; to participate in risk financing, which included investing (indirectly) in companies involved in clients' futures; and to excel at asset and liability management. Swiss Re was to be a major risk warehouse in the three-party convergence play, as it rationalised its acquisitions and streamlined its underwriting and capital policy.

Making it work

Against the trend, Swiss Re slashed its North America proportional business in the mid-1990s in favour of excess of loss business. The move included a reorganisation in the US and the decentralisation of decision-making. The process was completed in 1996, the same year a French branch office was opened and group asset management was consolidated in Zurich (close to Credit Suisse). The group structure was reorganised in 1997 to consolidate acquisitions. Performance continued to break records. Swiss Re sold its captive management and loss control businesses, and formed a strategic alliance with Crawford to run its loss-making loss adjusting business, which it later exchanged for a stake in Crawford, marking its exit from loss adjusting. It formed another with Policy Management Systems Corp, a US insurance IT provider, invested in Allied World Assurance Co, Inreon, a Lloyd's marine operation, an in-house run-off services provider, and, inexplicably bought 15% of LEKS, a tiny Estonian insurer which since has been merged away.

In May 1999, Swiss Re launched its much-publicised `Triple 20' programme, with the group-wide aim of dropping or renegotiating the 20% of its contracts with the lowest value, reducing catastrophe 20% by dropping business sold at burning cost or below, and by trimming administrative expenses by two points. The company claimed to have got about halfway to reaching the goals in the 1999/2000 renewal, as the first wafting hints of a hardening market floated over the sector. After two years, it was hailed as a success, particularly in turning around unprofitable non-life underwriting, although losses on less traditional Swiss Re exposures held back results, with Messrs Kielholz and Forstmoser singling out weather contracts and large corporate accounts in their 2000 report. Swiss Re was again reorganised, this time into three business groups representing non-life, life and asset management businesses, all serviced by a `corporate centre'.

An accounting change in 2000 to `new basis Swiss GAAP' flattered earnings somewhat, but brought Swiss Re closer to international standards. The difference between the price of acquisitions and their asset value was to be described as goodwill, to be amortised over five to 20 years, rather than offsetting retained earnings. The net present value of future earnings from life business was recorded as an asset and was also to be amortised. Instead of recording minority shareholdings at the lower of market value or cost, they were to be recorded at `fair value'. Laudably, the recording of income from transactions with little risk transfer became fee income instead of premium, while claims became expenses. Unless transparent, liabilities related to finite reinsurance were no longer to be discounted.

With the capital markets expertise of Credit Suisse on tap, Swiss Re was an early issuer of `hybrid capital'. It raised money through instruments such as subordinated perpetual bonds (SUPERBS), subordinated perpetual auction reset capital solvency (PARCS, where the yield fluctuates annually) and exchangeable bonds, which could be swapped by the investor for shares in Swiss Re, Credit Suisse or Novartis. In April 1999, Swiss Re sold its 20% interest in CS Financial Products to its banking partner and increased its holding in Credit Suisse group (although never to more than 5%). It was then able to release SFr450m backing its former indemnities relating to the company. The money was added to claims reserves.

Swiss Re was one of the innovators of catastrophe-linked bonds, contingent capital structures triggered by insurance-type losses, derivative products related to natural hazard risk, and credit-related risk transfer instruments. In the latter area, it acquired credit insurers NCM and Maryland Netherlands Credit (all later merged with Gerling Credit and sold), Italian bond insurer Società Italiana Cauzioni, US surety businesses Washington International Insurance and International Collections Inc, and 5.9% of CapMAC Holdings (an insurer which wrote financial guarantees for asset-backed securities deals). Strategy-wise, the massive investments in credit risk - a business perched on the border of banking and insurance - was said to fit well with risk-adjusted capital allocations.

Final analysis

Swiss Re's investors have reason to be satisfied with the performance of their reinsurer during the Mühlemann/Kielholz years, notwithstanding the recent share price slump. Growth was the main characteristic: the top line, the bottom line, and, most important, earnings per share and dividends declared all grew dramatically. Yet there is a certain sense of gravity-defiance in the performance, especially in the most recent years, when its major competitors have made massive reserve additions to compensate for soft-cycle losses.

Whether a reserving black hole will be discovered in the future remains to be seen, but Swiss Re has made a number of moves in the last eight years to limit the likelihood, including some important commutations (for example with Equitas), some cautious reserving (for example in 1997, when actual losses fell but reserving reduced the combined ratio), and the withdrawal from US medical business. Yet other actions - such as acquiring M&G Re without a guarantee from the vendors against adverse reserve development - seem to boost the potential for future pain.

Investment performance was strong throughout the period, as Swiss Re rode the back of the equity bull market and took advantage of links with Credit Suisse. While much conventional wisdom says that insurers make poor investment trusts (as the bank is now learning the hard way through Winterthur), big risk carriers provide an exceptional float for investing (as Warren Buffet so often espouses). At Swiss Re, real organic growth in life premium has been significant, but increased premium, investment income and technical reserves have often been driven by the inclusion of new totals from acquisitions, and sometimes were partially offset by the drawing down of catastrophe reserves (for example, SFr696m in 1999, to cover European windstorms Lothar and Martin).

As time passes, faith becomes a more important attribute for Swiss Re investors. Notwithstanding the aforementioned plunging share price, in 2001 Swiss Re reported its first ever net loss.

However, it continued to pay a dividend (much reduced, to SFr2.50, due to a 20-for-one stock split). Also that year it effected a massive, SFr6bn fundraising (in part to finance its acquisition of Lincoln Re). The issue was the largest equity and equity-linked offering for a financial institution that year, and the largest-ever capital increase in Switzerland. In addition, some SFr3.4bn in capital gains were realised, in part from selling NCM but also from cashing in on increases in the bond portfolio, as interest rates languished.

Reigns of power

On 11 November 2002, Swiss Re appointed John Coomber, actuary, incumbent head of the Life & Health Business group and lifetime Swiss Re man, to replace Mr Kielholz, who moves up to become vice chairman (just as Mr Mühlemann had done six years earlier). Mr Coomber's promotion emphasises the new importance of life business in Swiss Re's portfolio, and its contribution to profits. However, the announcement left little doubt as to whose strategic vision would drive Swiss Re forward. "The board of directors will continue to delegate special responsibility to Walter Kielholz, in particular related to the Group's strategic direction setting, top management development and interfacing with the executive board," Swiss Re said. Although Mr Mühlemann has left the glowing spotlights of the boardroom, any change in the architecture of Swiss Re's strategy seems some way off.

Has it been the right strategy? Dabbling in capital market risk, credit enhancement, weather derivatives, residual value and other non-insurance risks have cost Swiss Re dearly, and its acquisitions have been expensive. However, rationalisation of those businesses, selling the primary companies, Triple 20, global expansion, approaching the largest corporates direct, and a thundering entry into life reinsurance have given Swiss Re a broad risk spread and an enviable worldwide presence which can be leveraged in the hardening reinsurance market. And some of its painful adventures in convergence can be chalked up to experience. It has become a leader in several innovative fields. Its connection to Credit Suisse has provided valuable extended skills for many of its capital markets exploits for itself and for clients, but has proved sufficiently loose that Swiss Re avoided being dragged into the bank's quagmire.

Standard & Poor's stripped Swiss Re of its triple-A rating in October, citing "marginal non-life underwriting performance, a decline in capital adequacy since the end of 2001, and somewhat reduced financial flexibility". The downgrade is unlikely to affect clients' cession decisions, but the financial strength of Swiss Re has undoubtedly been weakened through a combination of losses, collapsing investment markets and acquisitions. Its asset base has been eroded, as have those of most of its competitors.

The proof of the convergence pudding will be in the eating. Big profits have been made, but some of Swiss Re's experiments have already proved costly, for example its $55m contingent equity deal with La Salle Re, which evolved into a stake of uncertain value in reinsurer Trenwick. More negative outcomes are certainly in the pipeline. The extent of capital erosion, the likelihood that it will continue, and Swiss Re's ability to rebuild its capital base in the long term are the key unknown factors for the world's number two reinsurer, and they are factors not entirely within its control. Unquestionably, though, the Mühlemann/Kielholz years have utterly transformed Swiss Re, and propelled it to the top of the reinsurance food chain in a global market itself fundamentally changed from the time they began. In many instances, Swiss Re was a vanguard of that change. A much-hailed new era of reinsurance is said to be beginning, and Swiss Re should be ready for it.

By Adrian Leonard

Adrian Leonard is a freelance insurance journalist and a regular contributor to Global Reinsurance.