Analysts predict that the reinsurer could buy back up to $2bn shares to improve return on equity as it re-risks to offset low bond-yield pressure
Swiss Re looks to be back on track after a solid set of results and the early repayment of $3bn (£1.86bn) to Warren Buffett, and its prospects are good for a return to a double-A rating. However, there is still work to be done at the world’s second-largest reinsurer.
Analysts are in little doubt that Swiss Re is back on an even keel after suffering heavily in the financial crisis.
In addition to underwriting, Swiss Re had also taken a large amount of risk on the asset side of its balance sheet, in particular by investing in credit default swaps. This decision had prompted some people to comment that Swiss Re had become more like an investment bank than a reinsurer. This was an argument reinforced by the fact that, until February last year, it was run by former investment banker Jacques Aigrain.
No longer justified
Like the investment banks, Swiss Re's decision to make risky investments costs it dearly. Unrealised losses on its investment portfolio wiped CHF11bn (£7.05bn) from the company’s full-year 2008 shareholders’ equity. But the de-risking and re-underwriting programme employed by new chief Stefan Lippe – a reinsurance underwriter rather than a banker – has started to pay off. Swiss Re’s profit surged to $1.59bn in the first nine months of the year, from $102m in the same period last year.
JP Morgan insurance analyst Michael Huttner says: “It is basically back to being a normal reinsurer, so that discount we have is no longer justified any more.”
Jefferies equity analyst James Shuck agrees. “Swiss Re is trading at 0.73 times book value, which is well below where it should be trading,” he says. “Profitability is very solid, albeit benefiting a little bit at the moment from what you might call good luck in terms of an absence of large losses.”
More investment risk
However, having stripped a lot of the risk out of its investment portfolio, Swiss Re is facing a low interest rate environment with a low-yielding investment portfolio.
While reporting that analysts did not ask a lot of questions about the asset side of Swiss Re’s balance sheet following the results, Huttner says analysts did ask the company to “please take more investment risk!”.
In addition, while analysts raved about the third-quarter property/casualty result, the performance of the life and health book left little to be desired. The reinsurer’s P&C division made operating income of $1.1bn for the third quarter of 2010, compared with $900m in the third quarter of 2009. However, third-quarter life and health operating income fell to $119m from $363m.
Starting to re-risk gradually
“P&C was a bit better than expected, and life and health was a bit worse,” says Helvea analyst Tim Dawson.
Nevertheless, the future looks bright for Swiss Re. While analysts argue that clearing the Berkshire Hathaway debt early will not save Swiss Re a lot of money, removing it will free the insurer to take more risks, albeit closely controlled.
Shuck says: “Now they have got the Berkshire debt out the way, they can start to focus on running the business properly and starting to re-risk gradually to help offset the low bond-yield pressure.”
He predicts that having removed the Berkshire debt from its balance sheet, Swiss Re could look at doing a share buy-back of between $1bn and $2bn in 2011 to improve return on equity (ROE).
“At the moment, Swiss Re is making an ROE of roughly 8%," he says, "and I think that there is about a one percentage point drag from excess capital."