(The following statement was released by the rating agency)
Sept 27 -
Summary analysis -- Munich Reinsurance Co. ------------------------ 27-Sep-2012
CREDIT RATING: AA-/Stable/-- Country: Germany
Primary SIC: Insurance
Credit Rating History:
Local currency Foreign currency
23-Mar-2009 AA-/-- AA-/--
22-Dec-2006 AA-/-- --/--
The ratings on Germany-based global reinsurer Munich Reinsurance Co. and its related core entities (collectively, Munich Re ) reflect the group’s very strong competitive position, very strong financial flexibility and capitalization, and strong enterprise risk management (ERM), in Standard & Poor’s Ratings Services’ view. These factors are partly offset by the group’s operating performance, which is strong, but in our opinion is a relative weakness for the ratings, as well as by the continued unfavorable risk-return profile of the group’s domestic primary life insurance business.
We view Munich Re’s competitive position as very strong. Munich Re’s competitive strength is predominantly founded on the group’s position as a leading global reinsurer in property/casualty and life reinsurance, with a highly recognizable brand, superior diversification, and significant scale advantages. In primary insurance, the competitive strengths continue to be less pronounced, in our opinion.
We consider Munich Re’s financial flexibility and capitalization to be very strong. Capital volatility and the quality of capital compares well with that of peers, given the group’s limited reliance on soft forms of capital. Financial leverage, coverage ratios, and the use of hybrid capital are all conservative relative to the current ratings, in our view.
Munich Re’s capital adequacy remained very strong in 2011, in line with our expectations, against large natural catastrophes and material financial market volatility. We do, however, believe that Munich Re’s primary life insurance business in Germany in the ongoing low interest rate environment remains a constraint for the group’s capitalization. In our assessment of capital adequacy, we include some benefit from our review of Munich Re’s economic capital model, which we assessed as good. Munich Re’s exposure to Southern European sovereign and bank debt has been significantly reduced in 2011 and in the first half of 2012 and in our view is manageable and not a major rating concern. Within our base-case assumption, we expect capital adequacy to remain stable and redundant on the ‘AA’ level according to Standard & Poor’s capital model in 2012 and 2013.
We regard Munich Re’s ERM framework as strong. A key factor in our assessment is Munich Re’s strong, embedded strategic risk-management concept that enables the group to manage risk-adjusted returns. In our view, stringent ERM processes have contributed to a resilient operating performance and capitalization relative to peers’ throughout the difficult financial market and claims environment.
Munich Re has demonstrated a relatively resilient operating performance in 2011. It reported a net income of EUR712 million and a return on equity of about 3% during challenging market conditions, caused by, for example large natural catastrophes (2011 natural catastrophes and man made losses of EUR5.1 billion compared with a five-year average of EUR2.2 billion) and capital market volatility (depreciation on investments mainly Greek sovereign debt of EUR1.6 billion). This can be attributed to the group benefiting from a well-diversified and partly uncorrelated earnings mix between property/casualty reinsurance, life reinsurance, and its primary insurance operations. We regard its underlying earnings capacity as strong, although we continue to view it as a relative weakness for the ratings. This predominantly reflects underwriting results in the property/casualty reinsurance portfolio, which in our view do not fully reflect its very strong competitive position. We also believe that the ongoing low interest rate environment will continue to put pressure on the group’s earnings. Thus, in our base-case assumption we forecast that the total investment return will decrease to about 3.5% in 2012 and 2013 from about 4.3% in 2011. In the absence of large losses above the budget of about EUR2 billion in 2012, we anticipate a strong improvement in property/casualty reinsurance with a combined ratio of 97%-98%--according to our definition--in 2012 and 2013 (2011: 114.2%). Our base-case scenario also assumes that the group will continue to implement restructuring measures in its non domestic primary property casualty insurance business, which we expect will lead to an overall combined ratio in primary insurance of 95%-96% in 2012-2013 (2011: 99.4%). Standard & Poor’s also anticipates that Munich Re will continue to leverage its very strong position in the global life reinsurance sector in order to generate stable income streams with a technical result of about EUR400 million and a new business value of EUR450-EUR500 million, in 2012 and 2013. As a consequence, bottom line results in our view should recover to about EUR2.0 billion-EUR2.5 billion in 2012 and 2013.
In our opinion, Munich Re’s domestic primary life business continues to demonstrate an unfavorable risk return profile. This became apparent in 2011 market-consistent embedded value (MCEV) results for the German primary life insurance business that reported a negative Value in Force for 2011 of EUR2.9 billion. However, we recognize that Munich Re is applying a very conservative calculation approach compared with peers, not taking into account an illiquidity premium. 10 basis points (bps) would be an increase in MCEV by EUR674 million or 77% and we observe an illiquidity premium of about 70-90 bps used by peers in the European Economic Monetary Union (EMU or eurozone) depending on portfolio mixes. We think it likely that the operating performance of this business will remain subdued in the medium term because of declining life business volumes and margin pressure from low investment yields. We do however, forecast a recovery in the new-business margin toward 1.5%-2.0% (2011: 0.5% for primary insurance including health and international business), based on a new business mix over the medium term.
The stable outlook reflects our expectation that Munich Re’s capital position and earnings will prove resilient to further volatility in economic and financial market conditions and that its underwriting performance will remain strong.
We would consider a positive rating action if the global and, in particular, European economic and financial market conditions improve and Munich Re demonstrates the sustained ability to yield profitable business growth and very strong underlying earnings in the reinsurance segment. This would be coupled with a sustained recovery in the primary insurance segment that more strongly compensates for potential volatility in property/casualty reinsurance.
Although unlikely at this stage, a negative rating action could occur, if Munich Re’s capital falls into the ‘A’ category for a sustained period, as a result of investment charges or large natural catastrophes. Failure of Munich Re’s primary insurance business to meet its performance targets over a prolonged period could affect our view of this segment as core to the group.
Related Criteria And Research
All articles listed below are available on RatingsDirect on the Global Credit Portal, unless otherwise stated.
-- General Criteria: Principles Of Credit Ratings, Feb. 16, 2011
-- Management And Corporate Strategy Of Insurers: Methodology And Assumptions, Jan. 20, 2011
-- Refined Methodology And Assumptions For Analyzing Insurer Capital Adequacy Using The Risk-Based Insurance Capital Model, June 7, 2010
-- Interactive Ratings Methodology, April 22, 2009
-- Group Methodology, April 22, 2009