London, 02 October 2012 -- Moody's Investors Service has affirmed the Aa3 insurance financial strength ratings (IFSR) of Munich Reinsurance Company ("Munich Re" or "Group"), its US non-life reinsurance subsidiary, and its primary German life insurance subsidiaries. Munich Re's debt ratings have also been affirmed. (See list below for more details). The rating outlook is stable.
The rating affirmation reflects Munich Re's excellent business franchise, strong business diversification and capital adequacy, relatively conservative investment portfolio, together with conservative management practices. These strengths are offset somewhat by some profitability challenges posed by the low interest rate environment, and the inherent volatility of its catastrophe exposed business.
Munich Re is one of the leading global reinsurers with a stable franchise and Moody's continues to view its reinsurance market position as excellent in both absolute and relative terms. Munich Re has a significant market share in P&C reinsurance, and the Group writes most of its business directly, frequently being the lead reinsurer on programmes. Munich Re was also the leading global life reinsurer by premium during 2011, albeit with a relatively small presence in the US market-place. The Group has also continued to enhance its franchise strength in the US P&C market via increasing its broker and niche primary insurance business with acquisitions a feature. Via ERGO Versicherungsruppe (ERGO), the Group is also Germany's third largest primary insurer with a German life market share of around 7% and a lower German non-life market share of around 6%.
Moody's also continues to view Munich Re's business and geographic diversification as strong. The Group writes a significant amount of less volatile Life & Health reinsurance business (45% of reinsurance GPW at YE11) which although not without risk, generally has a low correlation with P&C risks. The Group's primary insurance operations at YE11 accounted for around 39% of total GPW, albeit orientated towards life and health and German business (respectively c.71% and c.70% of total primary business). Moody's views this primary insurance business as credit positive for the Group's product risk and diversification, although earnings diversification is relatively muted. Notably, ERGO brings significant interest rate risk which the Group continues to mitigate via increase of asset duration and swaptions, and opposite interest-rate sensitivities in primary and reinsurance mitigate sensitivity at the Group level.
Other credit strengths for the Group include excellent financial flexibility, notwithstanding relatively low earnings cover, and a relatively conservative investment portfolio. In particular, Moody's notes the Group's continued low equities exposure (only 2.2% (net of hedging) of invested assets at H1 12), the very good quality of the fixed-income portfolio around 77% of which is government/semi government and Pfandbriefe/Covered bonds, and a low amount of non-agency structured products. At H1 12, total gross exposure to government bonds issued by Ireland, Italy, Greece, Spain and Portugal amounted to around EUR 4.5bn, and this exposure is relatively high compared to reinsurance peers. However, at around 2% of total invested assets and around 16% of equity (including Group free RfB and Terminal Bonuses), Moody's views the exposure as manageable, and notes that over 85% of the gross exposure, which reduced during 2011 mainly through the sale of Italian government bonds and EUR 1.2 billion of write-downs on Greek government bonds, is subject to policyholder participation.
Capital adequacy is viewed as strong. Munich Re's YE11 economic risk capital coverage, based on the requirements of its internal risk model (175% of VaR 99.5%) remained above 100% at 111% (post dividend), though reduced from 136% at YE10 impacted, inter alia, by lower interest rates. The Group's YE11 regulatory solvency position of 245% is also high though reduced from 261% at YE10. Nevertheless, the gross underwriting leverage metric for the reinsurance business is somewhat high at 3.7x (YE10: 3.4x), although the Group's natural catastrophe exposures on a combined gross and net basis at the 99.6% aggregate PML remain within Moody's Aa parameters.
Off-setting these strengths somewhat are some profitability challenges posed by the low interest rate environment which is suppressing running investment yields. In particular, Moody's believes that ERGO's performance, especially in its life business, is currently some way below the Group's 15% RORAC target. ERGO's life business produced an IFRS profit at year-end 2011, albeit a modest one, but most striking were negative earnings of around EUR2.6 billion for German life on a Market Consistent Embedded Value (MCEV) basis. Whilst recognising that Munich Re does not apply interest surcharges such as illiquidity premiums in its MCEV calculation, its German life business is meaningfully exposed to spread deficiency risk as a result of its guaranteed products.
Another challenge for the Group is the inherent volatility of its' catastrophe exposed business. The Group's average return on capital (ROC) from 2007-2011 of around 7.5% and its relatively low sharpe ratio of 197% were negatively impacted by the low ROC and RORAC of 2.4% and 3.2% respectively in 2011, a year heavily impacted by Nat Cat losses as reflected in the reinsurance combined ratio of 113.6%. However, we believe that the Group, like its peers, should benefit from improved P&C reinsurance pricing during 2012, and we note the significantly improved result at H1 12, compared to H1 11, with a reported RORAC of 13.1% benefiting from materially less major loss claims.
The affirmation of the Aa3 insurance financial strength ratings on ERGO Lebensversicherung AG, (formally Hamburg-Mannheimer Versicherungs AG) and Victoria Lebensversicherung AG reflect their importance within ERGO Versicherungsgruppe (ERGO), the primary insurance operations of the Munich Re Group, and some benefit of parental support that Moody's considers to be available for these operations. The ratings also reflect ERGO's position as the third largest life insurance company in Germany, its well-diversified business profile and its extensive distribution network. In addition, risk mitigation through a swaption program has reduced exposure to persistently low interest rates. However, ERGO lost market share in recent years, and although the market position in the last 3 years has stabilised, achieving profitable growth is likely to be one of the main challenges in the near term where the prolonged low interest rate environment is likely to continue to exert pressure on earnings.
Moody's also affirmed the Aa3 insurance financial strength rating of Munich Reinsurance America, Inc. (MRAm) and the A2 senior debt rating of Munich Re America Corporation (MRAC), reflecting strong explicit and implicit support from Munich Re and the strategic importance of the US operations to the overall Group. MRAC is well diversified across products and distribution channels, and has developed strong relationships with many clients through direct distribution. These strengths are tempered by soft pricing in casualty lines in more recent accident years, by persistent competition from other global reinsurers, and by the inherent volatility of various reinsurance business lines. During 2011, MRAC reported GAAP net income of $794 million.
The rating agency noted the following factors could put upward pressure on Munich Re's ratings: sustained strong core earnings with return on capital of 12-14% over the underwriting cycle, financial leverage in the mid- to high teens (15-19%), earnings coverage of 9-14x. Conversely, the following factors could put negative pressure on the ratings: return on capital over the underwriting cycle below 7%, financial leverage consistently above 25% and earnings coverage consistently below 6x, reduction in shareholders' equity of >10% over a 12 month period due to catastrophe losses or poor operating results, significant deterioration in asset quality
The following ratings were affirmed with a stable outlook:
Munich Reinsurance Company - Aa3 insurance financial strength rating, A2 (hyb) subordinated debt rating, A3 (hyb) junior subordinated debt rating
Munich Reinsurance America, Inc.- Aa3 insurance financial strength rating
Munich Re America Corporation- A2 senior debt rating
ERGO Lebensversicherung AG -- Aa3 insurance financial strength rating;
Victoria Lebensversicherung AG -- Aa3 insurance financial strength rating;
The principal methodology used in these ratings was Moody's Global Rating Methodology for Reinsurers published in December 2011. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.
Based in Munich, Germany, Munich Re reported gross premiums written of Eur49.6 billion, equity of Eur23.3 billion, and net income of Eur702 million as at YE11.
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