Munich Re would boost ROE by 1% without self-imposed limits on debt

Munich Re could increase its return on equity by 1 percent if it were to ease its prude approach to leverage and self-imposed limits on how much debt it is willing to take on.

That is the conclusion of equity research firm Jefferies in a paper examining the performance of Munich Re, published on June 3.

It found that Munich Re’s long-term average return on equity outperformed both SCOR and Swiss Re by 0.5-1.4 percent, even before accounting for its lower leverage, which it estimates costs Munich Re another 1 percent, and its lower reliance on realised gains.

Jefferies looked at the reinsurer’s historical returns, hypothetically adjusting the leverage to a level in line with peers (25 percent). In doing so, it found that over the nine year period from 2011 to 2019 this would have increased Munich Re's average return on equity from 8.3 percent to 9.1 percent.

Factoring in our forecasts out until 2023F as well would suggest an increase of 1 percent from 8.5 percent to 9.5 percent. “Though it's our view that such an increase would not be worth the corresponding increase in the risk premium (unless a suitably high quality asset can be bought with the capital), this higher ROE perhaps provides a fairer basis of comparison with peers,” the firm said.

Jefferies stressed in the paper that despite the self-imposed debt limitation, the group's relative return on equity has still exceeded many peers across the cycle. Since 2012, Munich Re's average quarterly ROE has been 9.3 percent, 0.5 percent ahead of SCOR's 8.8 percent and 1.4 percent ahead of Swiss Re's 7.9 percent.

Although Hannover Re beat this with 13.7 percent, it notes that Munich Re has over this period been considerably more exposed to low yields, making the achievement of such a high return even more notable.

“In our view, such long-term outperformance demonstrates the group's high quality underwriting, particularly as the period includes a both a benign period (2012 - 2016) and highly active catastrophe period (2017 - 1Q 2020).”

As well as maintaining a consistently higher return on equity than the more highly levered reinsurers, Munich Re's returns are also higher quality, with a lower proportion of the investment return achieved through realising gains, the equity research firm said.

“Thus, while Munich Re has achieved an average return of 0.3 percent from realised gains, SCOR and Swiss Re have achieved 0.7 percent. In the case of SCOR, this is due to the sale of a material real estate investment, but in the case of Swiss Re, this appears to be the result of unusually high harvesting of gains in four of the last six quarters.

“As this coincides with the widening gap between Swiss Re's return on equity and its peers, it appears that the underlying ROE has deteriorated even further relative to peers. Given that Munich Re has an outsized quantity of unrealised gains through ERGO's exposure to long duration assets, this under-reliance on gains further confirms the group's prudence.”