The Tremors Shaking Munich Re

Can the world's largest reinsurer stem the red ink and win back its sterling credit rating?

The merrymaking at the annual end-of-summer bash for insurance industry executives in Monte Carlo was a sober affair this year for the participants from Munich Re, the world's largest reinsurer. Just days before descending on the luxury resort to socialize and swap business gossip, the reinsurance firm reported to investors that it had lost $680 million in the first half of 2003, after earning $1.2 billion in 2002.

Further dampening the mood: On Aug. 27, the firm's credit rating was lowered a notch from AA- to A+ by Standard & Poor's, which cited Munich Re's weak profits and diminished capital base, along with its equity exposure to other limping German financial titans such as insurer Allianz and HVB Group in its $187 billion investment portfolio. "At this stage in the cycle it should be performing better than it has been," says Nigel Bond, an S&P analyst in London.

All of this represents quite a tumble for a company that boasted a coveted AAA rating as recently as December, 2002. All the more so in the cloistered world of reinsurance, where billions of dollars of corporate and private-risk coverage are guaranteed by a few top firms. The slightest slip in creditworthiness is a big blow, since it raises questions about the underwriter's ability to make good on claims when disaster strikes. Of course, no one is suggesting the company, which still has a strong Aa3 rating from Moody's Investors Service, would find it difficult to meet any of the obligations likely to come its way. "Munich Re is a group that is virtually unparalleled among international financial-service providers with regard to quality, experience, global structure, and networking," says Chief Executive Hans-Jürgen Schinzler. He insists that the group's underlying performance is strong.

VICIOUS CIRCLE? But a lower rating -- Munich Re is the lowest-rated of all major European reinsurers -- makes it a less attractive counterparty than better-rated rivals and could therefore crimp its ability to win new business. Of course, it hasn't been an easy few years for reinsurance. The industry has been forced to pay out huge claims related to the September 11 attacks in the U.S. and to a series of natural disasters in Europe, including floods last year. But what really put Munich Re's management in a funk as they packed their bags for Monte Carlo were fears about a future squeeze on the company's premium income, which topped $45 billion last year, 10% more than in 2001.

The wave of bad news this year for Munich Re, which owns Princeton (N.J.)-based American Re Corp. as well as Ergo, Germany's second-largest primary insurer, comes at a time when most reinsurers around the world are recovering. Munich Re is also doing somewhat better, but S&P's Bond and other analysts say the group is being dragged down by bad equity investments and its cross-shareholding with Allianz, which is also its biggest customer. Munich Re owns 20% of Allianz, has a 26% stake in HVB, and a 10% slice of Commerzbank, all of which are performing dismally. What's worse, German firms such as Munich Re aren't able to write off equity losses against taxes. The setback to the portfolio transformed a second-quarter $847 million operating profit into a stinging net loss.

The credit-rating downgrade came at a particularly bad time because it could extend Munich Re's losing streak by forcing it to lower premiums to keep clients. "The big worry is that a ratings cut can be the start of a vicious circle," says one London insurance broker. "You have to pay more for business as a result, which means profits fall and your rating can get cut again." Not surprisingly, Munich Re is highly critical of the S&P move. "S&P's reinsurance model," says CEO Schinzler, "obviously fails to take account of the strengths of Munich Re."

Those are fighting words in the staid business of reinsurance. But the ill tidings may have already claimed an important victim: Schinzler himself. The 62-year-old CEO announced in April that he will retire when his current contract expires in December. Although Munich Re insists the departure is voluntary, the announcement was as unexpected as the name of his dark-horse replacement: 46-year-old Bavarian aristocrat Nikolaus von Bomhard. "We were also surprised -- pleasantly -- by the choice of successor," says Chris Hitchings, an analyst at Commerzbank Securities in London.


Von Bomhard, who joined Munich Re in 1985, is expected to shake things up. He may already have started. In June, the firm announced that Clement Booth, the 48-year-old director in charge of risk management, strategic planning, and investor relations, would step down at the end of September "for personal reasons." (He has since landed the CEO's job at Aon Re International, a subsidiary of international insurance broker Aon Corp.) Some investors speculate Booth and von Bomhard clashed over whether to boost capital through a rights issue -- a move analysts say Munich Re needs desperately, but which von Bomhard apparently sees as a sign of weakness that could hurt the stock.

Analysts say von Bomhard may seek to make his mark by spinning off some Schinzler acquisitions -- including Ergo and its banking stakes -- and focusing Munich Re more clearly on its core reinsurance business. Says Michael Huttner, who follows the company for J.P. Morgan Chase & Co. in London: "He will probably want to refocus the group, a bit like Swiss Re has done in recent years." Much to Munich Re's chagrin, archrival Swiss Reinsurance Co., based in Zurich, has posted steady profits.

As a first step toward repairing its problems, Munich Re and Allianz, which in turn owns 20% of Munich Re, have agreed to reduce their cross-shareholding to 15%. When HVB's and Commerzbank's share prices rise to a respectable level, the remaining holdings, too, could be off-loaded.

However he rearranges Munich Re's business portfolio, von Bomhard's first priority has to be to get the firm back in the good graces of the credit agencies. "The problem isn't so much the level of Munich Re's capital as its quality," says S&P's Bond. "It's the heavy exposure to Allianz and the banks that is really worrying." The betting in Monte Carlo is that unless von Bomhard cleans house by selling off money-losing assets, Munich Re is not likely to see its gold-plated AAA rating again anytime soon.

By David Fairlamb

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