Swiss Re FY13 results – finally time to take profits

Key points:

1. Swiss Re has posted a strong profit result – 4Q13 NPAT US$1.21bn and FY13 US$4.4bn
2. However, the reinsurance pricing cycle appears to have peaked and is now on a downward trend. This was confirmed with Swiss Re reporting both volume and pricing was down in the January reinsurance renewals
3. After almost five years of holding an overweight bias on Swiss Re, it is finally time to cash-in and take some profits

Last Thursday, Swiss Re released their 4Q13 and full year 2013 results to 31 December 2013. As has become the norm, Swiss Re convincingly beat the market consensus with a very strong 4Q13 NPAT of US$1.21bn (versus expectations of US$796m). For the full year, NPAT was a healthy US$4.4bn, up from US$4.2bn in FY12.

The good result was on the back of low natural catastrophe payouts and “reserve releases” (i.e. writing back provisions for payouts no longer expected) and continued solid investment performance.

Highlights of the result included:

• NPAT US$1.21bn for 4Q13 (US$795m 4Q12) and US$4.4bn for FY13 (US$4.2bn FY12)
• Total premium and fee income for the year grew 13% to US$28.8bn
• Group combined ratio remains very low at 85.3% for FY13 (83.1% FY12) as low natural catastrophe (nat cat) payouts continued for a second year. Actual nat cat claims were US$483m below forecast for FY13
• Property & Casualty Reinsurance remained the largest and most profitable division with net income of US$3.3bn for FY13 (US$3.0bn FY12) and a combined ratio of 83.3% (80.7% FY12)
• Life & Health Reinsurance result was impacted by further “reserve strengthening” (i.e. increased provisions) for the Australian group disability business. As a result, the division’s contribution was down 52% to US$356m for the year
• Corporate Solutions continued to grow with premium revenue up 28.0% to US$2.9bn and a contribution to profit US$279m for the year (US$196m FY12). Combined ratio was 95.1% for FY13 (96.2% FY12)
• Capital position weakened slightly with shareholders' equity of US$33.0bn as at 31 December 2013, down US$1.0bn from a year earlier. Total dividend payouts proposed in the FY13 results totalled US$3.1bn, including the announcement of another special dividend. The company estimated that it continues to hold in excess of US$10bn in capital above the amount required by Standard & Poor’s at the AA rating level. Swiss solvency test ratio was steady at 229%
• Investment book remains very strong. Investment income (which is already counted in the divisional net income figures above) was an excellent US$4.3bn for the year. Return on investments was 3.6% in FY13 (4.0% FY12)

However, despite the strong results, the market for reinsurance is weakening. In January 2014, Standard & Poor’s released a report entitled “Past The Tipping Point: Competition And Soft Pricing Could Lead To Rating Pressure For Global Reinsurers” which stated “The tables seem to have turned for the global reinsurance sector, with reinsurers experiencing increased competition and curtailed profitability, which could result in downgrades in 2014-15. For the first time since 2006, Standard & Poor’s Rating Services is expecting to see more negative rating actions in the sector than positive ones.”
According to indices released by Guy Carpenter (the global reinsurance advisor and service provider) European natural catastrophe reinsurance rates fell to their lowest level since 2000 in the January 2014 renewals, with UK pricing down 15% year on year and European prices down 10%.

Swiss Re reported a subdued outlook for 2014 on the back of a 3.6% decline in pricing on the January 2014 renewals. There was also a 6% decline in volume for the same month renewals.

The lack of natural catastrophes of recent has reduced pricing and demand.

The very strong capital position of Swiss Re also gives the company the ability to undertake large capital returns. As reported above, another special dividend was announced last week, on top of an increase in ordinary dividend. The company has proposed US$3.1bn in dividends be paid out. While this is music to the ears of equity investors, it decreases the buffer below bond holders and has seen total equity decline over the past year.

Conclusion

Swiss Re remains a very strong credit however the continuous price appreciation over the years (as demonstrated in the charts below) and the downward turn in the price of reinsurance has led to a position where we finally think it is time to take some profits.

We have had an overweight bias on Swiss Re Tier 1 securities for almost five years (since it was “half price” at around $50 in early 2009) and it has remained a cornerstone investment in the majority of wholesale investors’ portfolios.

On a trading margin basis, the Swiss Re fixed rate Tier 1 securities can be sold at a trading margin of around 280bps to first call date which equates to an indicative price of $104.50 on the fixed and $95.25 on the FRN. Given the additional risks that exist from being down the capital structure in a reinsurance company (i.e. unpredictable natural catastrophes) this margin is considered only “fair” in the current environment.

When you then add in uncertainty over call risk (including the potential for early regulatory call – see "Credit Suisse calls Tier 1 hybrid early" article), the reward is considered to fall a little short of the risk, particularly for the fixed rate security which will only ever repay investors $100 (most likely at first call date in May 2017). This means that while investors are receiving a high 7.635% p.a. fixed coupon, they will lose circa $4.50 between now and the call/redemption date. Assuming that occurs in May 2017, this equates to approximately -1.56% per annum that must be deducted from the coupon.

On the flip side, in the unlikely even the securities weren’t to be called, both the fixed and the FRN Tier 1 securities revert to floating at 180day BBSW plus 2.17% (equivalent to a current rate of approximately 4.83%) and both would be expected to fall into the low $90s.

As such, investors should consider removing some of the uncertainty and look to take some profits at the current record high prices. Investors should also assess the balance of their overall portfolio and if Swiss Re (and insurance in general) represents a large position, consider selling down some exposure.

It is also important to consider diversification within fixed income portfolios. While Swiss Re has minimum parcel amounts of $100,000, many bonds are now available in parcels as small as $10,000 through FIIG, allowing for greater diversity of holdings.

The following table lists a number of alternative investments.

Table 1

For further information on Swiss Re or alternative investments/portfolios, please contact your local dealer. 

All prices and yields are a guide only and subject to market availability.  FIIG does not make a market in these securities. Swiss Re Tier 1 hybrid securities are only available to wholesale investors.