Key points
1. Swiss Re announced its second quarter results to 30 June, 2014, (2Q14) last Wednesday with a headline net profit after tax of US $802m for the quarter, up from USD $786 in 2Q13.
- Despite reporting consistently strong results (in part due to benign natural catastrophe occurrence in recent times) and the undoubted high credit quality of Swiss Re and their Tier 1 perpetual securities, investors should assess whether it is time to cash in with many sitting on large profits and double digit annual holding period returns.
3. Swiss Re Tier 1 securities (in AUD and non-AUD) are viewed as fair value at current levels but offer little upside with ever-present downside risk. Re-insurance is a far more volatile type of insurance that incorporates an element of luck. If an event such as Hurricane Katrina or a number of sizeable natural catastrophes all occurred in a short timeframe, significant losses and capital reductions could occur which could impact credit ratings, credit spreads and regulatory call decisions
Swiss Re announced another strong quarterly result last Wednesday with a net profit of USD 802m for 2Q14, up slightly on 2Q13 result of USD 786m but down on 1Q14 of USD 1,226m.
The company is on track to record a third consecutive full year profit of more than USD 4bn, an impressive achievement. However, we note that low natural catastrophe payouts and relatively strong investment returns (in a low interest rate environment) are increasingly important factors in the result.
The company reported tough conditions in natural catastrophe renewals, which often occurs following a period of low natural catastrophe events/insurance claims. There has been some suggestion that underwriting standards have been lowered in order to increase the volume of business written, which would result in an increase in risk of the insurance book.
As highlighted in our recent updates, the company continues to return capital to shareholders with special dividends and other capital management activities. As a result, shareholders’ equity fell from USD 33.9bn to USD 32.5bn over the quarter, mainly as a result of USD 3.1bn in dividend payments more than offsetting the USD 802 net profit for the quarter and other unrealised gains on investments of USD 900m.
While Swiss Re maintains a very high capital buffer and we do not expect management to jeopardise its credit rating, any reduction in the equity/capital buffer is negative for bond holders.
Relative value summary
Overall, the 2Q14 results were a continuation of a very strong profitability streak for Swiss re that dates back almost three years. This strong performance has allowed the company to return capital to shareholders and maintain the current credit ratings. However, the environment for reinsurers is clearly getting tougher and investors are encouraged to assess whether it is time to cash in on one of the best performing fixed income investments over the past few years (as demonstrated by the charts below which plot the yield to call and margin to call of the AUD fixed and floating Tier 1 perpetual securities).
Figure 1
Figure 2
With the strong rally in credit over the past year, the Swiss Re Tier 1 perpetual securities (in AUD and non-AUD) are viewed as fair value and not particularly expensive given the lack of alternatives at similar yield. However, investors in the money or wanting to remove any call risk may consider taking profits.
Reinsurance is a far more volatile type of insurance that incorporates an element of luck. If an event such as Hurricane Katrina or a number of sizeable natural catastrophes all occurred in a short timeframe, significant losses and capital reductions could occur which could impact credit ratings, credit spreads and regulatory call decisions.
While the Tier 1 securities are assessed as fair value at current levels, they offer little upside but with ever-present downside risk inherent in reinsurance.
The fixed and floating AUD Swiss Re Tier 1 perpetual securities with a call date of 25 May 2017 are available wholesale investors only in minimum (face value) parcels sizes of $100,000.There are also a number of other issues in non-AUD available to wholesale investors in various minimum parcel sizes. Please contact your FIIG representative if you require any further information.
All prices and yields are a guide only and subject to market availability. FIIG does not make a market in these securities.