Restoring Munich Re

Can CEO Nikolaus von Bomhard sustain the reinsurer’s recovery while keeping activists at bay?


Nikolaus von Bomhard is no stranger to adversity. When the 52-year-old reinsurance veteran became chief executive of Munich Reinsurance Co. in January 2004, the German company was reeling from a string of disasters — mostly man-made. Heavy investment exposure to equities and an ill-fated expansion in the U.S. had been hammering earnings since 2001, and the company was about to report a €434 million loss (then worth $536 million) for 2003 because of massive write-downs at HypoVereinsbank, the German bank in which it owned a 25.7 percent stake. Standard & Poor’s had recently cut the reinsurer’s credit rating by one notch, to A+, hiking the group’s funding costs. And shareholders, peeved at Munich Re’s tightfisted approach to distributing profits, had begun agitating for the sale of the group’s primary insurance business, Ergo Insurance Group. To add insult to injury, Munich Re was on the verge of losing its long-standing perch as the world’s biggest reinsurer to longtime rival Swiss Reinsurance Co., whose bold acquisitions and embrace of newfangled securitization techniques were winning favor from investors.

Far from panicking, the new boss attacked those problems with the cold eye of a practiced underwriter. Von Bomhard tightened controls on his army of underwriters and insisted that they stress profit margins rather than market share, arguing that the company had to be willing to lose business if it wanted to make money on reinsurance contracts rather than simply rely on investment income. “Value creation should take place on the liability side of the balance sheet — not the asset side,” he tells Institutional Investor. That he granted an interview at all is itself a welcome sign of change at the traditionally secretive company. Unlike his predecessors, who rarely spoke to journalists or analysts, von Bomhard meets regularly with outsiders to discuss the group’s results and strategy.

The CEO’s conservative financial approach has helped Munich Re emerge virtually unscathed — so far, anyway — from the financial market turmoil stemming from the implosion of the U.S. subprime mortgage market. Munich Re slashed the percentage of equities in its investment portfolio to just 10.8 percent at the end of 2007, down from 14.1 percent a year earlier and more than 25 percent at the start of the decade, insulating it from the volatility of global stock markets. The group has also largely avoided the structured products at the heart of the market crisis. Munich Re’s holdings of subprime mortgage securities amounted to just €340 million at the end of 2007, and the company took a modest €166 million in write-downs. By contrast, Swiss Re took a Sf1.3 billion ($1.2 billion) charge on credit default swaps it wrote to help clients hedge holdings of U.S. mortgage-backed securities.

“We have been called ‘reassuringly boring,’” says von Bomhard, a tall, slim, balding man who favors dark, somber suits and prefers lengthy, erudite replies to sound bites. “That’s a real compliment, because in the risk business it’s best to be as predictable and down-to-earth as possible.”

In addition to keeping a firm grip on reinsurance risks, von Bomhard is also looking for growth in an unusual area: primary insurance. In contrast to rivals who have largely pulled back from directly providing health, life or property/casualty insurance, von Bomhard is eager to expand Munich Re’s Ergo subsidiary, which ranks as the second-largest insurer in Germany. The strategy is controversial, to say the least. Odey Asset Management, an activist U.K. hedge fund that acquired a stake of less than 1 percent in Munich Re last year, has called on the company to unload Ergo. That view is believed to be shared by Cevian Capital, a Stockholm-based activist fund that paid €800 million in December for 3 percent of Munich Re. Cevian executives decline to comment directly on Ergo but are putting pressure on von Bomhard to improve shareholder returns. “We think Munich Re is undervalued,” managing partner Lars Förberg tells II. “And we have identified a number of areas in which we think its business could be improved.”

Von Bomhard is sticking to his guns, though — and to Ergo. He insists there are big synergies between the subsidiary and the group’s mainstream reinsurance operations. “Most of the skills you need in reinsurance are the same ones required for primary insurance,” he explains.

The CEO’s sober demeanor and back-to-basics philosophy may lack excitement, but they have produced sparkling financial results. Under von Bomhard’s leadership, Munich Re has racked up four consecutive years of record earnings. The company recently reported net income of €3.9 billion for 2007, up 11.9 percent from a year earlier, even though the strengthening of the euro against the dollar caused premium income to slip by 0.5 percent, to €37.3 billion. Of that total, reinsurance generated 55 percent of the premiums and insurance contributed 45 percent. The company’s shares have lagged, though. Munich Re stock was trading at €123.47 late last month, up 28.5 percent since von Bomhard took over as CEO but down 68.4 percent from its November 2000 peak. To placate long-suffering shareholders the company raised its dividend last year by 22.2 percent, to €5.50 a share — or a total of €1.1 billion — and returned an additional €3 billion to shareholders via buybacks in the 14 months ended in mid-April 2008; von Bomhard has promised to shell out at least €3.9 billion more in dividends and buybacks by the end of 2010.

This performance has brought the company and its boss plaudits from competitors. “Munich Re is the gold standard in the reinsurance business,” says Ajit Jain, president of Warren Buffett’s Stamford, Connecticut–based Berkshire Hathaway Reinsurance Group, the world’s third-largest reinsurer. “I spend half my time trying to figure out how to copy what von Bomhard is doing.”

The contrast with Swiss Re is particularly sweet for von Bomhard. Subprime write-downs led the Zurich-based reinsurer to report an 8.7 percent decline in earnings last year, to Sf4.2 billion; total premiums rose 7.2 percent, to Sf31.6 billion, reflecting the first full-year contribution from GE Insurance Solutions, the world’s fifth-largest reinsurer, which Swiss Re purchased from General Electric Co. for $6.8 billion in 2006.

The impact of von Bomhard’s vaunted discipline also shows up in other comparisons of the two industry giants. Some 67 percent of Munich Re’s reinsurance business comes up for renewal every January, as does 64 percent of Swiss Re’s. Renewal prices declined by about 9 percent this year for the reinsurance industry as whole, but Munich Re experienced a decline of only 2.8 percent in average prices and 4 percent in overall premium volume; at Swiss Re the declines were 3 percent and 12 percent, respectively.

Meanwhile, Swiss Re has had to scramble to maintain its own promise to return Sf7.75 billion to shareholders through buybacks between 2007 and 2010. The company struck a deal with Berkshire Hathaway in January under which the U.S. company bought a 3 percent stake in Swiss Re for Sf893 million and wrote a reinsurance contract that effectively gives Berkshire Hathaway a 20 percent share of Swiss Re’s property/casualty business for the next five years. The transaction will free up capital to allow Swiss Re to continue share buybacks, but some analysts and fund managers believe Berkshire Hathaway got the better end of the deal. “It’s highly unusual for the No. 1 reinsurance company to cede 20 percent of its p/c premiums to the No. 3 reinsurer — which is viewed by many as a lender of last resort,” says Markus Engels, a Frankfurt-based insurance analyst for Cominvest Asset Management. “As a Swiss Re shareholder, you don’t want to have exposure to only 80 percent of the profitable p/c business if you bought your shares thinking it was for 100 percent of the business.” Swiss Re CEO Jacques Aigrain said in a February 2008 press release that the deal would reduce earnings volatility and help the company actively manage the p/c rate cycle.

Von Bomhard would like to give more cash to shareholders too. He is pressing rating agencies to permit reinsurers such as Munich Re, which regained its AA– rating from S&P in 2006, to carry more debt on their books without risking their ratings. “We could certainly give back more capital to our shareholders if we weren’t limited by rating agency restrictions,” says von Bomhard.

But with Group of Seven governments and the Financial Stability Forum calling on financial firms to raise more capital because of the credit market turmoil, von Bomhard’s initiative seems wildly inopportune. “Short term there will be no relief for Munich Re and other insurers on capital requirements from the credit rating agencies, which are shell-shocked by recent developments,” says Cominvest’s Engels. “But in the medium term, we may well see some changes.”

The dramatic turnaround at Munich Re notwithstanding, von Bomhard still faces plenty of challenges. The most severe is in the U.S., the world’s biggest reinsurance market. The company incurred heavy losses from the global stock market meltdown at the start of this decade and from the September 11, 2001, terrorist attacks on New York and Washington. Reinsurance rates soared at first, but after fresh capital flooded into the industry and competition intensified, Munich Re’s U.S. subsidiary, then called American Re, tried to expand its market share as premiums fell. The unit posted a massive $1 billion loss in 2006.

Von Bomhard moved to take greater control last year, renaming the business Munich Re America and imposing the same information technology platform and underwriting standards used by the group’s European business. The result? The U.S. operation returned to the black, but aftertax earnings were only $169 million — a paltry sum for a business that generated 23 percent of the group’s premiums.

Today, Munich Re has 5 percent of the U.S. reinsurance market, while Swiss Re boasts an 8 percent share, thanks to its purchase of GE Insurance Solutions. Von Bomhard and his team profess to be unconcerned by the gap. “In the current soft phase of the market, we do not want to increase our market share,” says Peter Röder, Munich Re’s head of global clients and North America. Growth will have to wait until “the next hard market,” when reinsurance rates are rising, he adds.

In the meantime, Munich Re is moving to boost its primary insurance business in the U.S. Last year the company acquired two specialty insurers, paying $1.3 billion in October for Cincinnati-based Midland Co., a p/c outfit that specializes in the niche markets for prefabricated housing and mobile homes, and $352 million in December for Sterling Life Insurance Co., a Bellingham, Washington–based health insurer catering to older Americans using Medicare Advantage plans. But the two companies aren’t likely to have a significant impact on Munich Re’s bottom line.

Moreover, some fund managers and analysts are unconvinced of the growth potential of the U.S. investments. “A plan for more share buybacks would have created value and been easier to communicate than these add-on acquisitions,” says Jürgen Hawlitzky, a Frankfurt-based senior analyst for global insurance at Allianz Global Investors.

A bigger issue for some investors is Munich Re’s primary insurance arm in Germany. Ergo, which Munich Re created in 1996 by combining four small insurers it acquired earlier that decade, accounted for €17.3 billion in premiums last year, or 45 percent of the group’s total, but delivered only €984 million in net profits, or 25 percent of group earnings. Some investors, including Odey, maintain there aren’t enough synergies between Ergo and Munich Re and that primary insurance ties up too much capital and distracts management from the group’s core reinsurance business. “Munich Re wants to hang on to all the primary insurance business as a protection against the reinsurance down cycle,” says Patrick Macaskie, Odey’s head of research. “But that doesn’t wash with us, because when we bought Munich Re, we were happy to accept direct exposure to reinsurance risks.”

Munich Re officials insist that Ergo belongs in the group. They claim strong synergies between insurance and reinsurance and cite Ergo’s profitability. The subsidiary’s p/c business earned €496 million last year, down from €616 million a year earlier because of claims from winter storm Kyrill in Europe. Its combined ratio, a key gauge of profitability that measures expenses as a percentage of premium income, stood at a healthy 93.1 last year, compared with 93.6 for German rival Allianz and 106.0 for the U.K.’s Aviva. Ergo is dwarfed by Allianz, though, which posted p/c operating profits of €6.3 billion last year.

Ergo has also had problems in its life business, a consequence of having offered high guaranteed returns in recent years despite the low level of interest rates, says Kevin Ryan, London-based director of equity research for ING Wholesale Banking. Torsten Oletzky, who took over as Ergo’s chief executive in January, insists this legacy has been overcome and that Ergo’s investment portfolio is now well positioned to carry the guarantees while paying effective returns for policyholders. He also vows to reduce costs further and to introduce new products, such as unit-linked insurance plans that tie the policy value of life insurance to the changing worth of the underlying assets. Profits at Ergo’s life and health business rose 16.7 percent last year, to €370 million, on a 21.3 percent jump in premiums, to €4.3 billion.

Whatever its difficulties in Germany, where Ergo generates more than 75 percent of its revenues and earnings, the company certainly benefits from Munich Re’s expertise and contacts abroad. In Turkey, Munich Re introduced Ergo to the Isviçre Group, which offers p/c, life and health insurance, leading to a joint venture in which Ergo paid €212.9 million for a 75 percent share of the Turkish company in 2006. Similarly, last year, thanks to Munich Re’s introductions, Ergo paid €41 million for a 26 percent stake in India’s HDFC General Insurance Co., which offers both life and nonlife products. Neither market produces significant income yet, but the German group is betting they will in the future.

Ergo reciprocates the help it receives from Munich Re: The company does 75 percent of its reinsurance with its parent. Only Allianz is a bigger Munich Re client. Oletzky says Ergo gets no breaks from Munich Re on reinsurance rates. Indeed, the company now retains — that is, does not reinsure — 100 percent of its car insurance business, reflecting a strategy of keeping more business on its balance sheet.

The biggest reason for holding on to Ergo, executives say, is that it diversifies the group’s risk exposure. But some analysts expressed skepticism after von Bomhard claimed during a February conference call that a new risk model showed that the diversification benefits could save the group €2 billion in capital, or five times as much as Munich Re had estimated a year earlier. The CEO declined to reveal further details until the company releases first-quarter 2008 results in May and credit rating agencies have had a chance to assess the new model. “A lot of people might ask, If there were problems with the old model, why weren’t they told about it before?” says ING’s Ryan.

Defining the relationship between reinsurance and insurance has been an issue at Munich Re since its beginnings. The company was founded in 1880 in a former Munich brewery by an ambitious, visionary insurance agent, Carl Thieme, who championed the novel notion that a reinsurer should be independent of primary insurers. The German insurance industry was foundering because of widespread flaws in risk assessment and the pricing of policies. Meanwhile, reinsurers were all owned by primary insurance companies — an arrangement that inspired little confidence among rival insurers. Thieme’s other new idea was that Munich Re should spread risk by writing policies for a variety of businesses throughout Germany, instead of just focusing on a few regions and one or two main lines, such as fire and marine insurance.

Thieme was on to something. Within five years, Munich Re became the world’s biggest reinsurer. In 1890, Thieme founded Allianz, a separate company that went on to become Germany’s largest primary insurer. That same year, Munich Re established a London office to handle its growing foreign clientele. In 1906 the San Francisco earthquake wiped out a score of German and American insurance companies, but despite huge losses, Munich Re burnished its reputation by promptly settling all claims — including a then-enormous $1 million payment made just a day after the quake.

Much worse was to come. In World War I, Munich Re saw its capital abroad confiscated. Only in the U.S. was it later returned. World War II obliterated Munich Re’s business and assets abroad and in eastern Germany, which emerged from the conflict as a separate, communist nation. For almost seven years after the end of the war, the reinsurer was unable to pay dividends.

In the four decades beginning in the early 1950s, Munich Re shared in Germany’s impressive growth and reclaimed its mantle as the world’s leading reinsurer. With the rise of Hans-Jürgen Schinzler to chief executive officer in 1993, the company ventured well beyond reinsurance in an attempt to become a financial services conglomerate. Although notoriously tight-lipped — Schinzler rarely gave interviews and held Munich Re’s first conference with securities analysts only in 2000 — the executive was ambitious. In 1996, Munich Re paid leveraged-buyout firm Kohlberg Kravis Roberts & Co. $3.3 billion to acquire American Re in a major expansion into the U.S. market. That same year, Schinzler thrust his company deep into primary insurance by merging four smaller insurance subsidiaries to create Ergo, which accounted for half of Munich Re’s revenues by 1998. In 2001, Munich Re bought a 25.7 percent stake in HypoVereinsbank in an attempt to sell insurance through the bank’s branches. A year later, the insurer acquired a 10.5 percent stake in Commerzbank.

But by 2003 it was apparent that Schinzler had overreached. Munich Re racked up huge losses in the U.S. The group paid out $2 billion in claims following the 2001 attack on the World Trade Center (Swiss Re’s bill was $875 million). In 2003, American Re required a $2 billion infusion. Adding to American Re’s problems were asbestos claims that eventually forced Munich Re to further shore up its subsidiary’s reserves by more than $600 million.

“They bought the company at the top of the cycle, didn’t really take control and allowed it to expand into a softening market with property and casualty business that proved to be very underpriced,” says Richard Hewitt, a London-based insurance analyst for Dresdner Kleinwort, an Allianz subsidiary.

In Germany, meanwhile, Schinzler came under intense pressure to shed noncore holdings. Munich Re and Allianz each owned a 21.2 percent stake in the other, an arrangement typical of the cross-shareholding relationships then prevalent among German blue chips. But in 2003, with both Allianz and Hypo-Vereinsbank struggling (the latter lost €2.6 billion thanks to bad property and corporate loans), Munich Re tumbled into the red and S&P downgraded its credit rating from AA– to A+. The company was forced to raise €3.8 billion with a rights issue in October 2003. Munich Re did not recover its AA– rating from S&P until December 2006.

In January 2004, Schinzler resigned as CEO and took up his current post as chairman. Von Bomhard was a more outgoing executive who, unlike his predecessor, had come up through the ranks as an underwriter. “I am the first reinsurance man in many decades to run the company,” he says. Born 150 kilometers northwest of Munich, in the small Bavarian town of Gunzenhausen, where his parents were university professors, he knew nothing about reinsurance or Munich Re before joining the company as a trainee in 1985 on the advice of an aunt who was a bank executive. And initially he didn’t plan to stay at the company — or in Munich. “I wanted to live elsewhere,” he says.

But rapid promotions soon changed von Bomhard’s mind. He became a fire reinsurance underwriter and rose to deputy chief of that operational division for Germany in 1992. From 1997 to 2000 he headed Munich Re’s Brazilian operations out of São Paulo. He was next promoted to Munich Re’s management board in charge of internal auditing, then to head of strategic planning for Europe and Latin America, before being anointed CEO, with a clear mandate to abandon Schinzler’s vision of a global financial giant and refocus on the group’s core insurance business.

His first order of business was to unravel cross-shareholdings with other companies and sell Munich Re’s big equity stakes. By last year the reinsurer had reduced its Commerzbank stake to less than 3 percent. It decreased its holding in HypoVereinsbank (which was acquired by Italy’s UniCredit in 2005) to less than 5 percent. Today, Munich Re and Allianz own less than 3 percent of each other. “There are no longer any significant ties, aside from the fact that Allianz is still our biggest client,” says Munich Re global client chief Röder.

In 2004 von Bomhard set a group goal of raising annual net income to €3 billion, something that the company achieved two years later. The turnaround permitted Munich Re to announce in May 2007 its plan to return €8 billion to shareholders through buybacks and higher dividends by 2010.

To some analysts and fund managers, the plan — launched under the slogan “Changing Gear” — seemed a response to increasing shareholder pressure and to similar moves by archrival Swiss Re, which had announced its own buyback plan in March 2007. This sort of generosity on the part of the two leading reinsurers was overdue in an industry whose returns on revenues and equity had long disappointed investors. According to S&P, the top ten global reinsurers averaged an annual return on revenues of only 5.8 percent from 2002 through 2006. Both Munich Re and Swiss Re struggled to reach a 15 percent return on equity during those years, compared with the 20-plus percent achieved by many banks before the current global financial crisis. And the share price performance of both companies has been dire. Munich Re’s stock price stood at €123.47 late last month, down from €219.92 a decade ago. During the same period, Swiss Re’s share price plunged to Sf85.55 from Sf165.13.

Even with the rising emphasis on primary insurance, Munich Re acknowledges that success will ultimately depend on how well it runs its traditional reinsurance business. Reinsurance contributed more than three fourths of the group’s €3.9 billion in net income last year, and appears set to deliver a similar proportion in 2008. The aim, says von Bomhard, is to “grow at the right time” without letting profit margins collapse and “again being perceived by investors as never getting it right.”

In the past a prolonged soft reinsurance market would inevitably lead to serious price erosion. But Munich Re executives insist this time will be different because more carrots and sticks are being offered to their underwriters. “Bonuses and promotions are now exclusively tied to discipline,” says Munich Re’s head of reinsurance, Torsten Jeworrek. Clearer lines of management responsibility mean that “when things go wrong, you can no longer duck and dive,” says Andreas Molck-Ude, head of Munich Re’s Middle East and Africa division. Managers exercise tighter control by monitoring the computer screens of Munich Re underwriters — and of the managing general agents, or MGAs, hired to represent the reinsurer — so that senior supervisors can view on an hourly basis what is being underwritten and at what price. In January, Munich Re severed contracts with ten car insurance MGAs in South Africa because of insufficient pricing discipline.

Although concern about renewal prices tends to become obsessive in a soft market, Munich Re insists it is paying as much attention to drumming up new clients as to keeping established ones. The reinsurer leverages its size and experience to get into such traditional reinsurance businesses as large real estate development projects even before ground is broken. “Reinsurance at the start of a big new construction project is driven by actuaries and model structuring of risks — and local primary insurers often don’t have the resources and experience to evaluate these risks,” says Bernd Kohn, who oversees Munich Re’s new business development.

In the United Arab Emirates, for example, Munich Re is a lead participant in the $1 billion construction insurance contract for the Burj Dubai, the world’s tallest building, due to be completed in 2009, and in the $34 billion insurance contract for Abu Dhabi’s Yas Island development, a huge leisure and shopping complex on which construction began in 2007.

Developing new risk models, even to cover familiar catastrophe scenarios, is an ongoing concern. The flooding of the Elbe and Donau Rivers in 2002 — the worst in Germany in more than a century — caused €17 billion in total damages and cost the insurance industry €3.4 billion, of which Munich Re paid more than €400 million. The disaster pointed up the need for a better computer risk model to more accurately determine the probability of a variety of flood events in Germany and to segment the damages they could cause. Earlier versions only measured rainfall and tried to predict resulting flood levels.

The newer model — a €2 million project developed by IAWG, a small German research company, and financed by a Munich Re–led group of insurers and reinsurers — came up with about 10,000 simulated events covering scenarios that ranged from very small floods affecting only limited areas to the sort of twin-river mayhem of 2002. In effect, it allows insurers and reinsurers to better calibrate their rates, charging low prices for lesser risks and much higher prices for greater risks.

Some analysts profess to be impressed by such models — but only up to a point. “Maybe it will help them to avoid some of their old mistakes,” says Dresdner Kleinwort’s Hewitt. “Of course, we don’t know yet if it will prevent them from making new ones.”

One risk-related product that Munich Re is unlikely to pursue is insurance-linked securities, which Swiss Re continues to market with vigor. Virtually nonexistent a decade ago, the ILS market has grown to a total issuance of $48.3 billion. Swiss Re has underwritten more than $13 billion worth of these bonds, whereas the total for Munich Re remains well below $1 billion.

Munich Re dismisses such securitizations as more of a promotional tool than a profit maker. “I doubt anyone earns big money yet in this exercise — we certainly don’t,” says von Bomhard. Even if, as Swiss Re projects, insurance-linked securities mushroom to more than $300 billion by 2015, Munich Re estimates that they will amount to no more than 5 percent of the total risk market.

Von Bomhard, no doubt with an eye on activist shareholders like Cevian and Odey, is eager to find other ways to save on capital. He sees getting the credit rating agencies to permit Munich Re to carry more debt on its books without lowering its double-A credit rating as essential. “Many of our clients — big insurance companies — have a double-A rating, so why would they turn to us for protection if we had a lesser rating than theirs?” asks reinsurance head Jeworrek.

Von Bomhard’s ambition runs counter to the current obsession among financial regulators and bankers with increasing capital in response to the global credit crisis, but rating agencies are reviewing their risk models for reinsurers and could eventually ease their capital standards. “The prospect in the long term is for decreasing capital requirements by S&P,” says Simon Marshall, London-based senior director of insurance and financial ratings at S&P.

Such a change would help Munich Re to drum up more business and more easily meet its earnings targets for each of the next two years. “And we could certainly give back more capital to shareholders if it were not for ratings considerations,” says Jeworrek.

For activist investors like Cevian and Odey, such givebacks would be the best way to ensure von Bomhard’s continued discipline. “If they have loads of money burning holes in their pocket, they will inevitably want to make some silly acquisitions,” notes Odey’s Macaskie.

Proud to Be Boring

A financial storm is raging in world markets, but at the palatial headquarters of Munich Reinsurance Co., confidence abounds. The sprawling art nouveau and neoclassical–style building with massive stone columns served as a virtual fortress for decades, a symbol of the company’s historical penchant for secrecy. But Nikolaus von Bomhard, who took over as CEO four years ago, has changed the group’s style as well as its strategy, meeting frequently with analysts and journalists.

With activist investors pressing him to divest primary insurer Ergo Insurance Group and focus on the company’s core reinsurance business, von Bomhard spoke recently with Institutional Investor Contributing Editor Jonathan Kandell while, appropriately enough, wind and rain battered the windows.

Institutional Investor: What has been the impact of the market turmoil on the insurance industry?

Von Bomhard: Overall, insurance companies should be less affected in their balance sheets than banks. That’s certainly true for us, because we have always been skeptical about what we have seen happening in the credit risk markets and kept our powder dry. That’s not always easy, because we got asked why we don’t go more into corporate bonds or structured credit products. Fortunately, we really stood firm. We insisted that the pricing wasn’t right, and that decision is paying off now.

Are Munich Re and Swiss Re Insurance Co. pursuing different strategies?

In the old days, Munich Re and Swiss Re were pretty much alike. That has changed over the last ten years. The companies are different — not in their core businesses but in what direction they think they should go.

The key to this business is understanding the risk, evaluating it and then binding it up in a way that you can offer clients a better solution than others. It takes a lot of experience and know-how. So we think that buy and hold is a solid principle. It’s not about thinking, How can I get rid of the risk and put it into God-knows-whose pockets. Securitization is an important additional instrument, but we won’t write business unless we are prepared to keep it on the books. It makes us look boring, but it protects us very well.

How do you respond to investor complaints that reinsurers’ returns on equity are low compared with those of banks?

I always ponder the relevance of ROE. There is no risk measurement involved in ROE. An underwriter can load his company with cat [catastrophe] risks, and in a good year the actual losses are very small, but he exposes a lot of the equity if a big hurricane strikes. Banks have had ROEs of 20 percent or more in recent years, and insurance companies keep asking themselves, “Aren’t we smart enough to get it right? We struggle to get ROEs of 12 percent.” Investors react by driving our share prices unbelievably low.

What is an appropriate return?

If you have a cost of capital of about 8 percent and you beat that by, say, 50 percent, or a 12 percent ROE, that’s a very decent return for any investor. People have gotten very greedy in recent years. Let’s be more modest and skeptical.

What are the main changes you have pushed as CEO?

I was the first reinsurance man in many decades to run the company. We emphasized that value creation should take place on the liability side of the balance sheet — not the asset side. That’s where we should know better. Building a platform with an annual net income in the €3 billion [$4.7 billion] range was our goal. By the end of 2006, we achieved that. So the question was, What next? That’s why we are jumping into insurance. Most of the skills you need in reinsurance you also need in primary. Insurance is more predictable, less volatile, less cyclical and in a different cycle than reinsurance. So we think it is a perfect addition.

Cevian Capital says more could be done to raise the company’s value. How do you respond?

We have regular contact with them. The various investors don’t always share all of our views, but they must like the company, otherwise they wouldn’t have invested in us. We think we are undervalued, and they share that view. The question is, What can be done to raise the share price? First of all, deliver, deliver and deliver. Ergo has been an issue since 2003, when it was announced I would be CEO. The first question asked of me at that press conference was, Will I sell Ergo? But it is a question that haunts me less and less. With Ergo outperforming almost all of its German and European peers, why on earth should we sell it? There is a very strong diversification benefit from keeping Ergo. It’s a good franchise, and it adds value for the shareholder. My personal goal is to make it clear to the capital markets that having Ergo makes us different from our peers. — J.K.