Munich Re, Hannover Re go for lower margin risk than SCOR

Munich Re and Hannover Re have embraced low margin, low volatility growth with a low Solvency II capital cost in 2018, while peers such as SCOR steer clear due to the high S&P rating capital cost, according to Jefferies analysts.

This is the explanation that analysts found for the “material divergence” in growth rates in 2018 between the German reinsurers and their Global Tier 1 peers at the Paris investor day.

“During the Jan. 1, 2018 renewals, one key point we had failed to properly appreciate was that the relative importance of differing capital treatments under Solvency II and S&P’s credit rating model would be the deciding factor in determining which reinsurers could most attractively price business,” the analysts said.

While under Solvency II the volatility of business is a key factor in determining the capital cost, under S&P’s credit rating model the premium volume is relatively more material, the analysts noted. “In the context of 2018 growth this difference became critical, as we understand that most organic growth came from just a handful of very large quota share agreements, with high premiums but low margin and low volatility,” according to Jefferies.

Solvency II capital cost is key for Hannover Re and Munich Re, the analysts said. In the case of the German reinsurers, their longstanding AA- rating from S&P means that large quota share agreements can be written at a low margin because the Solvency II capital cost is low, they explained.

SCOR runs closer to the S&P capital requirement, according to Jefferies. By comparison, although SCOR would be able to write these contracts for a similar Solvency II cost, the fact that the group has only relatively recently been upgraded to AA- means that credit rating requirements are a more critical limitation than Solvency II, the analysts noted.

The analysts believe that Munich Re is best prepared to face the challenges of the reinsurance sector.

Looking forward to January 1, 2019 reinsurance renewals, Jefferies expects pricing to struggle to improve unless catastrophe losses create another disappointing second half for earnings. “Given that 1/1/2018 was already slightly disappointing after such a magnitude of losses in 2017, a lack of rate rises in 2019 will mean that it is debatable whether the industry will be paid back for their 2017 losses in anything like a reasonable time frame,” the analysts said. “It does dampen our enthusiasm for the sector,” they added.

Jefferies analysts expect that the expense of equity backed, human underwriting will be directed to specialist risks, such as large corporate, luxury motor or facultative property in the future. In the future, the most relevant reinsurers are likely to actively guide their clients, perhaps through a broker, to the most cost-effective and relevant reinsurance solution. Thus, reinsurers would implement an account management model, where they advise clients on how to channel different risks to different forms of capital, be it a securitisation, a specialist fund, or the reinsurer’s own equity backed balance sheet, the analysts continued.

Munich Re remains the best to whether the rating storm, according to the analysts. “In our view, Munich Re remains the best-placed reinsurer to manage the insurance cycle. The group has by far the lowest leverage in the sector, meaning that should catastrophe losses surge, it will be one of the few industry participants capable of rapidly re-capitalising to invest into a hard market. Moreover, with €4.8 billion of excess reserves on our calculations, the P&C reinsurance earnings should in our view be capable of outlasting peers in this cycle,” analysts noted.

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