munich reinsurance company · 2019/5/3 · munich re is the largest global reinsurance group by...

FINANCIAL INSTITUTIONS

CREDIT OPINION3 May 2019

Update

RATINGS

Munich Reinsurance CompanyDomicile Germany

Long Term Rating Aa3

Type Insurance FinancialStrength

Outlook Stable

Please see the ratings section at the end of this reportfor more information. The ratings and outlook shownreflect information as of the publication date.

Contacts

Christian Badorff +49.69.70730.961VP-Senior [email protected]

Brandan Holmes +44.20.7772.1605VP-Sr Credit [email protected]

Antonello Aquino +44.20.7772.1582Associate Managing [email protected]

Nicolò Squercina +44.20.7772.1541Associate [email protected]

CLIENT SERVICES

Americas 1-212-553-1653

Asia Pacific 852-3551-3077

Japan 81-3-5408-4100

EMEA 44-20-7772-5454

Munich Reinsurance CompanyUpdate including FY 2018 results

SummaryMunich Reinsurance Company (Munich Re)’s Aa3 insurance financial strength (IFS) ratingreflects its excellent business franchise and very strong market position in global reinsurance,its broad diversification across geographies and business lines, strong capital adequacy andmoderate asset risk, together with relatively conservative reserving practices. These strengthsare partially offset by pressure on profitability due to challenging reinsurance pricing trends,along with the low interest rate environment, and the inherent volatility of the group'scatastrophe exposed business. In addition, while the group has made very good progress inrepositioning ERGO, there is still some uncertainty and execution risk associated with theongoing restructuring of that business, which commenced in 2016.

Exhibit 1

Munich Re's Net Income and Return on Capital

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

0

500

1,000

1,500

2,000

2,500

3,000

3,500

2014 2015 2016 2017 2018

Re

turn

on

avg

. Ca

pita

l (1 y

r. avg

RO

C)

Ne

t In

co

me

Net income (loss) attributable to common shareholders Return on avg. capital (1 yr. avg ROC)

Source: Company reports and Moody's Investors Service

Munich Re reported group net income of €2.3 billion for 2018 (2017: €0.4 billion) benefitingfrom stronger performance across all its major lines of business, despite above-averagenatural catastrophe losses and capital markets volatility during the year. Gross writtenpremiums remained broadly stable at €49 billion (2017: €49 billion), with the Group's P&CReinsurance division reporting a combined ratio of 99.4% (2017: 114.1%). The group's ERGOdivision performed above expectation, reporting a profit of €412 million for 2018 (2017: €273million) due to certain positive one-off items and strengthening underlying performance.The group's estimated Solvency II coverage ratio at the end of 2018 remained strong, atapproximately 245% (YE2017: 244%), including the impact of expected dividends andplanned share buybacks.

http://www.surveygizmo.com/s3/1133212/Rate-this-research?pubid=PBC_1151888

https://www.moodys.com/credit-ratings/Munich-Reinsurance-Company-credit-rating-600044381

MOODY'S INVESTORS SERVICE FINANCIAL INSTITUTIONS

Credit Strengths

» Leading global reinsurer with a very strong reinsurance franchise across all major lines and solid primary insurance operation inERGO

» Very well diversified business profile, across product/ risk type, geography and access point (i.e. reinsurance, primary, personal lines)

» Strong capital adequacy (quality of capital, SCR coverage) and conservative investment portfolio

» Significant scale, diversification, and technical expertise allow strong response to industry changes

Credit Challenges

» Challenging trading environment for reinsurers: underwriting profits under pressure from price softening, while investment incomelanguishes due to low interest rates

» Inherent volatility of catastrophe exposed business and long-tailed lines of business (including life reinsurance)

» Some uncertainty around mid- to long-term growth and earnings prospects of ERGO, particularly in life

OutlookThe outlook is stable, reflecting the Group's very strong market position, extensive diversification and very strong capitalisation.

Factors that Could Lead to an UpgradeAlthough there is limited potential for further upward pressure on the ratings over the next 12 to 18 months, the following factorswould further strengthen Munich Re's credit profile:

» Sustained strong core earnings with adjusted return on capital above 10% over the underwriting cycle, while maintaining lowvolatility in profitability

» Financial and total leverage consistently below 20%, together with earnings coverage over 10x through the cycle

» Material improvement in the business environment, including P&C reinsurance pricing and interest rates

Factors that Could Lead to a DowngradeThe following factors could place negative pressure on Munich Re's ratings:

» Return on capital of below 6% over the underwriting cycle, or a sharp increase in volatility of the returns

» Financial leverage consistently above 25% and earnings coverage consistently below 6x

» Material deterioration in the group’s risk profile, for example following rapid growth in volatile or risky business

» Meaningful and sustained adverse reserve development

» Reduction in shareholders' equity of more than 10% over a 12 month period due to catastrophe losses or poor operating results

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page onwww.moodys.com for the most updated credit rating action information and rating history.

2 3 May 2019 Munich Reinsurance Company: Update including FY 2018 results


Key Indicators

Exhibit 2

Munich Reinsurance Company 12 2018 2017 2016 2015 2014

As Reported (Euro Millions)Total Assets 270,172 265,722 267,805 268,868 272,984Total Shareholders' Equity 26,500 28,198 31,785 30,967 30,289Net income (loss) attributable to common shareholders 2,310 375 2,580 3,107 3,152Gross Premiums Written 49,064 49,115 48,851 50,374 48,848Net Premiums Written 46,707 47,550 47,325 48,505 47,225Moody's Adjusted RatiosHigh Risk Assets % Shareholders' Equity 88.0% 90.2% 71.8% 70.9% 66.9%Reinsurance Recoverable % Shareholders' Equity 13.0% 12.4% 10.1% 12.5% 15.7%Goodwill & Intangibles % Shareholders' Equity 40.6% 39.0% 37.5% 38.6% 40.6%Gross Underwriting Leverage 3.9x 3.7x 3.3x 3.4x 3.4xReturn on avg. capital (1 yr. avg ROC) 5.6% 0.9% 6.0% 7.5% 8.1%Sharpe Ratio of ROC (5 yr. avg) 197.0% 196.2% 687.4% 246.4% 244.4%Adv./(Fav.) Loss Dev. % Beg. Reserves (1 yr. avg) -4.2% -2.4% -3.1% -3.4% -2.8%Financial Leverage 17.0% 15.3% 15.4% 16.1% 16.8%Total Leverage 19.3% 16.8% 18.4% 19.3% 20.2%Earnings Coverage (1 yr.) 8.0x 1.1x 8.8x 9.1x 7.2xSource: Company reports and Moody's Investors Service

ProfileMunich Re is the largest global reinsurance group by gross premiums written. It reported gross premiums written of €49 billion in 2018and shareholders' equity of €26.5 billion as of 31 December 2018. Munich Re is both the main operating and holding company of theMunich Re Group which encompasses P&C and L&H reinsurance, primary commercial insurance (through its Risk Solutions group), andprimary insurance operations through the ERGO Insurance Group (ERGO).

During 2018, Munich Re Group's business, the majority of which is conducted in Europe and North America, consisted of P&C and Lifereinsurance (64%), ERGO Germany (26%) and ERGO International (10%) lines. The largest business segments include P&C reinsurance(42%), Life reinsurance (22%) and Life & Health in Germany (19%).

Detailed credit considerationsExcellent reinsurance market position expected to continueMunich Re is one of the leading global reinsurers, with a very strong franchise and excellent reinsurance market position, both absoluteand relative terms. Munich Re has a significant market share in P&C reinsurance and the Group writes a significant portion of itsbusiness directly, frequently being the lead reinsurer on programmes. Munich Re is also a leading global life reinsurer by premium.

The Group's position as a top tier global reinsurer, supported by its leading research and development capabilities, depth and breadthof reinsurance capacity and excellent levels of client service, differentiate its market position from lower tier reinsurers, and increaseits resilience to headwinds facing the reinsurance sector. The Group's market position is further diversified and strengthened by itsprimary insurance business, most notably its ERGO subsidiary, which is one of the leading primary insurers in Germany and has a stronginternational presence in selected markets.

Munich Re continues to enhance its franchise strength in the US P&C market via increasing its broker and niche insurance business.In addition, it is one of the leading insurers with respect to innovation and positioning for the future, demonstrated by its growinginvolvement with a number of Insuretech companies, and leading position in the market for cyber insurance.

Business profile very well diversified across product and geographyThe Group is very well diversified by geography and business line. This limits the group's sensitivity to stress from any one source,reduces its earnings volatility, and allows it to reduce exposure to lines of insurance where prices are falling. Diversification is animportant strength of its credit profile and was evidenced in its strong 2018 performance, despite elevated industry-wide naturalcatastrophe losses, and financial markets volatility. The main lines of business within the group's traditional P&C reinsurance business


https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1141449


include Casualty (51%), Other Property (34%), Natural Catastrophe XL (7%) and Specialty (7%). Furthermore, the Group writes asignificant amount of Life & Health reinsurance business (35% of reinsurance GPW for 2018) which generally has a low correlation withP&C risks.

In terms of geographic diversification, the Group's reinsurance segment in recent years has become more orientated towards NorthAmerica (42%) and less towards Europe (31%), with continued growth in emerging markets also anticipated. However, as shown inExhibit 4, EMEA remains the largest segment in terms of total gross written premiums across all business lines, mainly because ofERGO's focus on EMEA.

Exhibit 3

Significant diversification across major business lines% Gross premiums earned by major division

Exhibit 4

Broad geographic diversification% Gross premiums written by major geography

28%

36%

19%

7%

10%22%

42%

19%

7%

10%

L&H Re P&C Re

ERGO Life & Health Germany ERGO P&C Germany

ERGO International

20182017

Source: Munich Re, 2018 Annual Report

9%

56%

35%

11%

59%

30%

Asia - Pacific EMEA Americas

2017 2018

Source: Munich Re, 2018 Annual Report

The Group also has meaningful primary insurance operations, albeit orientated towards life and health, 71% of which is derived fromtheir German business. Diversification benefits brought by ERGO's foreign operations in some cases offset by the lower profitability ofthese operations, although ERGO has taken significant steps to streamline its portfolio.

ERGO contributes significant interest rate risk which the Group continues to mitigate via increase of asset duration and swaptions, andopposite interest-rate sensitivities in primary and reinsurance mitigate sensitivity at the Group level.

High quality fixed income focused investments, with slightly riskier assets at the marginsOverall asset quality is viewed as very good, with the Group having a relatively conservative investment portfolio. High risk investedassets (HRA, i.e. investments in equities, alternative investments, non-owner occupied real estate, affiliates, non-investment grade/unrated fixed-income securities) as a % of shareholders' equity (which for all asset metrics includes Group free RfB and TerminalBonuses) increased in recent years to a relatively high 88% at YE2018, not accounting for hedging of equity exposures, reflecting bothan increase in HRA and a decrease in shareholders' equity. The increase in HRA is mainly driven by higher equity, real estate and non-investment grade credit risk exposure. As such, Munich Re's level of HRA relative to shareholders' equity is somewhat elevated relativeto its peers, however this is mainly due to inclusion of its primary life insurance operation, which inherently has higher asset leveragethan a typical reinsurance balance sheet. Adjusting for the primary insurance business, we estimate that Munich Re's ratio of HRA toequity would be closer to 50%.

The overall credit quality of the fixed-income portfolio at YE2018, which represents around 82% (including loans) of invested assetsand 76% of which is government/semi-government and Pfandbriefe/Covered bonds, is considered very good. 83% of the portfolio ofgovernment bonds, covered bonds and corporate bonds are rated above single-A.

With regard to other assets, at YE2018 the Group's reinsurance recoverables as a % of equity increased slightly to 13% (YE2017:12.4%), reflecting the slight increase in recoverables and decrease in shareholders' equity. Goodwill and intangibles (including DeferredAcquisition Costs, DAC) as a % of equity were 41% at YE2018, slightly up from 39% at YE2017, following primarily a decrease inshareholders' equity. This ratio is relatively high, although this is mainly driven by DAC (excluding total DAC from the calculation would



result in a figure of around 11%). Any potential depreciation of the DAC in the German life business would be partly offset through theprofit sharing mechanism.

Capital adequacy strong, both in terms of coverage level and quality of capitalCapital adequacy is strong, with solid levels of regulatory and economic capital, and moderate modelled nat-cat exposures comparedto its reinsurance peers. Regulatory capital, as measured by the group’s Solvency II ratio, is robust at approximately 245% at year-end 2018, and 244% at YE2017 (267% at YE2016), but has been somewhat volatile in the past, in part due to the group’s significantinterest rate exposure in its ERGO primary life insurance business. The Group's reported Solvency II ratio excludes transitional measures- primarily related to ERGO's life insurance book. Including transitionals, the ratio would be 295% at year-end 2018 (2017: 297%). Thegroup also benefits from a very high quality capital base, with around 90% of its eligible own funds being classified as Tier 1 capital.

The Group's gross and net natural catastrophe exposures at the 99.6% aggregate PML are respectively within Moody's Aa and Aparameters. Gross underwriting leverage for the Group is slightly elevated relative to peers, with the 2018 metric at 3.9x (2017: 3.7x),being somewhat inflated by the primary life business. Moody's notes that meaningful share buy-backs and dividends have been aconsistent feature of Munich Re's capital management with around €26.6 billion returned to shareholders from 2005-2018, althoughthis has been outweighed by net income in the same period, and Munich Re has bought back shares for another €1.0bn by the recent2019 AGM. In 2018, share buybacks have equated to €1.0bn (€1.0bn during 2017).

The group’s Solvency II ratio, which is based on an internal model that we consider to be an economic reflection of its business andrisks, remains resilient to a range of typical stress scenarios. For example, the year-end 2018 ratio would decrease to 222% in the eventof a 1-in-200 year Atlantic Hurricane event. As far as investment risks are concerned, the ratio would decrease to 227% in the eventof a 30% fall in equity markets, and to 225% in the event of a decrease in interest rates by 50bps (excluding the use of the volatilityadjustment).

Good profitability through-the-cycle although heavy catastrophe losses in 2017Moody’s considers Munich Re’s profitability to be solid with an average return on capital of 5.6% over the past five years through 2018and a strong net profit for 2018 of €2,310 million (€375 million in 2017), mainly due strong operating performances by ERGO and LifeReinsurance, and lower major loss experience during 2018 versus 2017. In addition, the Group's strong reserve position has enabledconsistent reserve releases, with 2018 reserve releases for P&C Reinsurance adding 4.6% points to the combined ratio for 2018 (2017:5.8% points).

However, profitability has been volatile in recent years given the group's meaningful cat-exposed property portfolio. This is highlightedby the relatively low Sharpe ratio of 197%, which is negatively impacted by the decline in net profit experienced in 2017, driven by €3billion in natural catastrophes during Q3 2017, including hurricanes Harvey, Irma, and Maria, as well as the Mexico earthquakes. Thehurricanes caused approximately €2.7bn in losses, and contributed to the €1.4bn net loss for the quarter.

Despite the group’s excellent franchise, it has not been fully insulated from the impact of softening reinsurance prices - over the pastfive years, return on capital has declined from 8.1% in 2014 to 5.6% in 2018, largely driven by deterioration in underwriting profitability,but also lower investment income. We expect Munich Re, and some of its peers, will benefit from price increases for reinsurance,particularly on US and Caribbean wind exposure that is renewed in June/July. However, we expect price hardening to be dampened bythe availability of alternative capital in the market, and for profitability to remain firmly below pre-2014 levels.

The Group's P&C reinsurance combined ratio for 2018 was 99.4% (2017: 114.1%), reflecting the high losses from catastrophes in thesecond-half of 2018, but less so than 2017. On a reported basis, this is above the 97.3% average combined ratio from 2013 to 2018,reflecting the weak reinsurance prices and elevated level of large losses during 2017 and 2018. During the four years ahead of 2016,Munich Re, like its peers, benefited from relatively low nat cat losses, which had offset some of the pressure of reinsurance pricesoftening.



Exhibit 5

Strong P&C profitability but significant loss in 2017Reported combined ratios for Munich Re's main business lines

92.7% 89.7%95.7%

114.1%

99.4%95.3% 97.9% 97.0% 97.5% 96.0%97.3%

104.7%98.0% 95.3% 94.6%

2014 2015 2016 2017 2018

Reinsurance P&C ERGO P&C (Germany) ERGO International

Source: Munich Re

During 2016, the group announced a significant restructuring initiative at ERGO, that seeks to position it as a more efficient andmodern global international insurer. The restructuring is expected to cost approximately €1 billion until 2020, after which the groupexpects ERGO to be in a position to contribute approximately €600 million to annual net profit. Thus far, ERGO's profitability hasimproved ahead of plan, reflecting particularly strong performance of ERGO International during 2018. ERGO's 2018 net income of€412 was comfortably ahead of management's €350 net income expectation for the year.

Conservative reserving stance and steady flow of reserve releasesThe YE2018 scorecard metric, which is within Moody's A parameter, is driven by a small reserve surplus position on average during2012-2018 (2.9% average release). The Group's strong reserve position has enabled consistent reserve releases, with 2018 reservereleases for P&C Reinsurance strengthening the combined ratio for 2018 by 4.6% points (2017: 5.8% points). Since 2008, MunichRe has consistently reported overall reserve surpluses totaling around €11 billion. Moody's notes that reserves at Munich Re America(formerly American Re) are exposed to US workers' compensation business and asbestos & environmental claims, and have requiredreserve strengthening in past years. Overall, we believe that Munich Re's reserve adequacy is consistent with that of an A ratedcompany due to the inherent difficulty of reserve estimation in certain long-tail lines of business.

Relatively low leverage, although earnings coverage constrained by pressure on earningsMunich Re's financial flexibility is strong, supported by moderate debt leverage, good earnings coverage, and reliable access to capitalmarkets. The Group's adjusted financial leverage was 17% at year-end 2018 (YE2017: 15.3%), with total leverage, which excludes anyequity credit for hybrid debt instruments, at 19.3% (YE2017: 16.8%). For 2018, the Group's earnings coverage stood at 8.0x which isin line with the levels recorded in the years prior to 2017. In 2017 earnings coverage decreased to 1.1x due to lower net income as aresult of the significant natural catastrophe losses incurred during the year. For the five year period to year-end 2018, earnings coverageaveraged 6.8x. Looking ahead, we expect earnings cover to remain slightly suppressed by pressures on Munich Re's earnings, arisingnotably from low interest rates and the reinsurance pricing environment, but we expect the earnings coverage to remain within the6x-7x range.

While the Group's capital structure consists mainly of equity, it had approximately EUR4.7 billion in debt outstanding at year-end 2018,primarily consisting of subordinated debt qualifying as Tier 2 capital under Solvency II. During Q4 2018, the Group issued an additionalEUR1.25 billion in subordinated debt, which has contributed, along with the reduction in shareholders' equity to the 170bps increase infinancial leverage compared to YE2017. Despite it not being a very frequent debt issuer, with no major issuances between 2012 and therecent 2018 subordinated debt issuance, we believe that Munich Re maintains strong access to capital markets, owing to its excellentfranchise and very strong credit profile.



Exhibit 6

Financial flexibility

0x

1x

2x

3x

4x

5x

6x

7x

8x

9x

10x

0%

5%

10%

15%

20%

25%

2014 2015 2016 2017 2018

Ea

rnin

gs C

ove

rag

e (1

yr.)

Le

ve

rag

e

Financial Leverage Total Leverage Earnings Coverage (1 yr.)

Source: Company reports and Moody's Investors Service

Support and structural considerationsMunich Re is both the holding company and main operating company of the Munich Re Group. In line with our notching practicefor reinsurance operating companies, we rate Munich Re's subordinated debt two notches lower than its insurance financial strengthrating.

Other considerationsClimate change risks and opportunitiesLike its P&C (re)insurance peers, Munich Re is exposed to the economic consequences of climate change, primarily through theunpredictable effect of climate change on the frequency and severity of weather-related catastrophic events, such as hurricanes, floods,convective storms, drought and wildfires. In the ordinary course of its business, the Group undertakes a number of steps to address thepossible impacts of climate change on its underwriting risk, including typically writing one-year policies on natural catastrophe-exposedbusiness that provide the ability to reassess risk exposures and pricing as climate conditions change, the frequent update of catastropheand pricing models to reflect changing environmental conditions, and using retrocessional coverage to manage risk exposures. Inaddition, the Group's extensive diversification by geography and business line reduces its exposure to risks related to climate change.

Munich Re also has opportunities to provide additional reinsurance coverage and risk transfer products to entities adopting climatechange adaptation strategies, including government programs (for example, the National Flood Insurance Program in the US) that usereinsurance as a means to manage natural catastrophe-risk.

Our rating analysis seeks to incorporate a forward-looking assessment of all material credit considerations, including those related toclimate change, to the extent that visibility into these risks and mitigants permits. Our assessment of risks related to climate changeand other environmental, social and governance (ESG) factors is in line with Moody's cross-sector methodology “General Principles forAssessing Environmental, Social and Governance Risks”.





Rating Methodology and Scorecard Factors

Exhibit 7Financial Strength Rating Scorecard [1][2] Aaa Aa A Baa Ba B Caa ScoreAdj ScoreBusiness Profile Aa AaMarket Position and Brand (20%) Aa Aa

- Relative Market Share Ratio X- Business profile - reinsurance - direct premiums % GPW (rating) X

Product Focus and Diversification (15%) Aa Aa- Business and Geographic Diversification X

Financial Profile A AaAsset Quality (10%) A Aa

- High Risk Assets % Shareholders' Equity 88.0%- Reinsurance Recoverable % Shareholders' Equity 13.0%- Goodwill & Intangibles % Shareholders' Equity 40.6%

Capital Adequacy (20%) A Aa- Gross Underwriting Leverage 3.9x- Gross Natural Catastrophe Exposure X- Net Natural Catastrophe Exposure X

Profitability (10%) A A- Return on Capital (5 yr. avg) 5.6%- Sharpe Ratio of ROC (5 yr. avg) 197.0%

Reserve Adequacy (10%) A A- Adverse (favorable) development % Beg. Reserves (7 yr. avg) -2.9%

Financial Flexibility (15%) Aa Aa- Financial Leverage 17.0%- Total Leverage 19.3%- Earnings Coverage (5 yr. avg) 6.8x

Operating Environment Aaa - A Aaa - AAggregate Profile A1 Aa3Source: Company reports and Moody's Investors Service



Ratings

Exhibit 8Category Moody's RatingMUNICH REINSURANCE COMPANY

Rating Outlook STAInsurance Financial Strength Aa3Subordinate A2 (hyb)

Source: Moody's Investors Service



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Additional terms for Japan only: Moody's Japan K.K. (“MJKK”) is a wholly-owned credit rating agency subsidiary of Moody's Group Japan G.K., which is wholly-owned by Moody’sOverseas Holdings Inc., a wholly-owned subsidiary of MCO. Moody’s SF Japan K.K. (“MSFJ”) is a wholly-owned credit rating agency subsidiary of MJKK. MSFJ is not a NationallyRecognized Statistical Rating Organization (“NRSRO”). Therefore, credit ratings assigned by MSFJ are Non-NRSRO Credit Ratings. Non-NRSRO Credit Ratings are assigned by anentity that is not a NRSRO and, consequently, the rated obligation will not qualify for certain types of treatment under U.S. laws. MJKK and MSFJ are credit rating agencies registeredwith the Japan Financial Services Agency and their registration numbers are FSA Commissioner (Ratings) No. 2 and 3 respectively.

MJKK or MSFJ (as applicable) hereby disclose that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferredstock rated by MJKK or MSFJ (as applicable) have, prior to assignment of any rating, agreed to pay to MJKK or MSFJ (as applicable) for ratings opinions and services rendered by it feesranging from JPY125,000 to approximately JPY250,000,000.

MJKK and MSFJ also maintain policies and procedures to address Japanese regulatory requirements.

REPORT NUMBER 1151888


http://www.moodys.com


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Americas 1-212-553-1653

Asia Pacific 852-3551-3077

Japan 81-3-5408-4100

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