Last week, Swiss Re reported their FY12 results to 31 December 2012
The company once again beat the market consensus with a strong full year result. Net profit after tax came in at US$4.2bn compared with US$2.6bn in FY11.
The table below summarises the financial highlights for FY12 by division.
Last year saw a continuation of very strong premium growth, with premium and fee income up 14.7% to US$25.4bn for the year. As previously reported, an increase in demand and price of insurance is typically experienced after a high occurrence of natural catastrophes/insurance events, as was the case in 2011. This trend started in late 2011 and has seen excellent revenue growth over the past year or so and is expected to continue into 2013, albeit at a lower level that that seen in 2012.
Profitability was aided by the lack of major insurance payouts, with the exception of an estimated US$900m payout for Hurricane Sandy.
Natural catastrophe premiums for 2012 were US$2,530m while payouts totaled just US$1,152m, demonstrating a very profitable year.
The budget for 2013 is for premium income of US$3,400m and expected payouts of US$1,750m. However, the unpredictable nature of the re-insurance business makes the estimated payout figure highly uncertain. As with any reinsurer, the key risk to the credit remains the number, severity and location of insurance payouts and the reinsurer’s ability to effectively manage those risks.
Another highlight was that the investment portfolio continues to perform despite the low yield environment. Investment income for FY12 was US$5.3bn (FY11 US$5.5bn), which represents a return on investment of 4.0% (FY11 4.4%) for a very low risk portfolio, supported by falling interest rates/yields and gains on fixed income investments.
Across a balance sheet with total assets of US$215.8bn and total investments of US$152.8bn (plus cash and cash equivalents of a further US$10.8bn), Swiss Re has a miniscule US$19m in direct exposure to PIIGS. The vast majority is in high quality, low risk Government bonds, particularly US Treasuries and other low risk fixed income assets.
Swiss Re looks to be reaping the rewards of the economic conditions and regulatory changes facing both banks (i.e. Basel III) and insurers (i.e. Solvency II) that encourages those financial institutions to seek to remove assets/risk from their balance sheets via reinsurance, creating a very attractive environment for Swiss Re to grow and cherry pick high yielding business.
At the end of December 2012 shareholders' equity was US$34.0bn (US$32.9bn common shareholders’ equity and US$1.1bn contingent capital instruments), up from US$29.6bn at December 2011. The strong growth is on the back of the US$4.2bn net profit for FY12 as well as the issuance of innovative contingent capital instruments that are accounted for as part of shareholders' equity.
This capital strength translates to a Swiss Solvency Regulatory ratio of 207%, more than double the regulator’s requirement.
However, the capital strength has indirectly created one of the few negatives from the release of the FY12 results. As highlighted in past research reports, management have been hinting at the possible return of capital to shareholders via special dividends or other capital management measures.
In the FY12 results release on 21 February 2013, the company announced an increase in ordinary dividend plus a special dividend which will see US$2.8bn returned to shareholders. However, even with this special dividend, the company remains very well capitalised and we do not expect any impact to the all important AA- credit rating.
Overall the performance of all divisions was strong and demonstrates a continued improvement in profitability to pre-GFC levels.
The table below details the financial highlights for the past six full year results. Net income has increased year on year since 2009 and is now above pre-GFC levels, demonstrating the excellent performance of the management team.
Conclusion
We continue to marvel at the outperformance in of Swiss Re since the GFC. The profit and loss and balance sheet is back to pre-GFC strength and the market outlook remains positive.
With respect to the Swiss Re Tier 1 hybrid securities we continue to believe they represent amongst the most compelling risk-return investments in the market despite the very strong rally over recent years. The Tier 1 securities of Swiss Re are rated two to three notches above listed Tier 1 hybrid securities issued by the major banks, however they continue to trade wider due to the market’s perception of call risk and exposure to Europe, both of which we believe are overstated. Moreover, we prefer the structure of the “old style” Swiss Re Tier 1 hybrid securities to the more equity like “new style” listed bank hybrids.
We also view Swiss Re as a far superior credit than AXA SA and at the time of writing believe Swiss Re should trade at least 150bps tighter than the equivalent AXA SA Tier 1 securities (which are now rated four notches lower than Swiss Re). The differential is currently circa 50bps for the fixed rate securities and circa 75bps for the floating securities. Given the current differential we would recommend that clients reduce weighting to AXA SA and consider an overweight position in Swiss Re, subject to the level of other financial and callable exposure in their overall portfolio.
Given these very strong results and the relative value opportunities we have removed Swiss Re from our “Reduce” list on our website, notwithstanding the broader theme of de-risk and diversify. Of the available Tier 1 hybrid securities, we continue to believe Swiss Re is the best risk/reward investment and these results only strengthen that view.
However, we also believe investors should reduce overall financial risk and call risk of their portfolios so an overweight position to Swiss Re should be made in the context of the balance and diversity of the entire fixed income portfolio.