Swiss Reinsurance Company (OTCPK:SSREY), generally known as Swiss Re, is one of the world's largest reinsurance companies. Like many of its peers, the company has a defensive profile and a conservative culture, leading to a very good capitalization and profitability, enabling it to offer attractive and sustainable shareholder remuneration policy in the long-term.
Swiss Re is a leading provider of reinsurance, insurance and other insurance-based forms of risk transfer. Swiss Re was founded in 1863 and has more than 12,000 employees around the world. The company is based in Zurich and has a market capitalization of about $33 billion. It trades in the U.S. on the over-the-counter market through its ADR program.
Given its business model, Swiss Re operates globally and its main clients are other insurance companies, corporations and public sector clients. Its major competitors are other large reinsurance companies, like Munich Re (OTCPK:MURGY), Hannover Re (OTCPK:HVRRY), Berkshire Hathaway (NYSE:BRK.B) and SCOR (OTCPK:SCRYY). Its closest competitor is Munich Re and the two companies together are the dominant players in the global reinsurance industry with a combined market share of about 35%. Like its closest peers, it is a conservative company with a low-risk profile, reflected in its high credit rating of AA- by Standard & Poor's.
Swiss Re's core business is reinsurance, being its largest business in terms of income and the foundation of its strength. The group's business is divided across four segments, namely Property & Casualty Reinsurance, Life & Health Reinsurance, Corporate Solutions and Admin Re. Its largest division in 2015 was P&C measured by net income, with a weight of 65% on the group's net income. Its second-largest unit was Life with a weight of 20%, while the other units have relatively small scale within the group. Geographically, its premiums are earned throughout the world, with a good diversification across Europe, Asia, Middle East and the Americas.
Reflecting its conservative culture, Swiss Re has a relatively low risk investment portfolio biased to government bonds, and higher risk assets having a low weight within the portfolio. For instance, equities represent only around 7% of its assets, showing that its asset allocation is quite conservative. The portfolio is mainly exposed to high-quality fixed income assets, such as government and covered bonds, and low exposure to securitized products.
Therefore, its earnings exposure to capital markets is quite low, but on the other hand its investment return should also be low given the current low interest rate environment in Europe. Indeed, interest rates are negative for its investment income and a headwind for its earnings growth going forward, given that reinvestment yields continue to fall and future income will therefore be lower than nowadays.
Swiss Re has undergone significant change in recent years, refocusing on core strengths and improving divisional disclosures and accountability for underperforming areas. The company aims to differentiate from competitors through financial strength, depth of expertise and a full service model. This enables it to focus more on large deals and in areas that are less commoditized, being therefore less subject to competition and giving it better price adequacy than for some of its reinsurance peers.
Regarding its financial performance, Swiss Re has been able to report quite good results over the past few years, despite the challenging operating environment. The reinsurance industry has faced a negative backdrop recently due to overcapacity and new competition from alternative players, which are chasing new areas of business as low interest rates make traditional fixed income investments less attractive.
This is leading to top-line pressure as premiums decline globally, making underlying earnings power of reinsurance companies weaker than a few years ago. After several years of rate declines, conditions in the P&C reinsurance market are accepted as highly competitive and should remain this way in the near future.
On the other hand, losses from natural catastrophes over the past few years have been lower than their historical average, totaling about $100 billion annually over the past couple of years. This number is way below the losses of the past decade, which were on average about $190 billion annually. This is a supportive factor for reinsurance companies, given that usually their reserving practices are quite conservative, leading to reserve releases in the following years when catastrophe costs come below budgeted levels.
Regarding its most recent results, Swiss Re's net premiums declined slightly in 2015, reflecting the price pressure on the reinsurance industry. The company reported a decline of 3.4% in premiums, to a total of $30.2 billion. Even though this is not a good achievement, it was better than for most of its peers that have reported steeper declines in premiums. However, Swiss Re was able to report higher earnings due to good underwriting and strong investment performance from asset management. Its combined ratio was 87% in 2015, a very good level and within its historical average of the past few years, enabling it to make sustainable operating profits. Reflecting this operating performance, its net income was up by 31% to about $4.6 billion. Its return on equity (ROE) was 13.7%, a very good profitability level and way above its goal of a ROE 700 basis points above the risk-free rate (target of about 8.3% in 2015).
During the first nine months of 2016, Swiss Re's operating performance has maintained its positive momentum supported by solid underwriting and investment results. Its premiums were up by more than 10%, a very good achievement given the pricing pressure within the reinsurance industry. All business units contributed to strong results, with P&C Reinsurance reporting a very high ROE of 21.6%.
Reflecting its conservative business culture, Swiss Re has strong economic capitalization measured by its solvency ratio, which is among the highest in the European insurance industry. At the end of 2015, its Swiss Solvency Test (NYSEARCA:SST) ratio was around 205%, a very good level compared to some of its closest peers. Given that Swiss Re is based in Switzerland, it is outside Solvency II jurisdiction; thus its solvency ratio is not directly comparable to its European peers based outside Switzerland.
Nevertheless, Swiss solvency rules are considered to be more demanding than Solvency II, showing that Swiss Re's solvency position is quite strong, taking into account that the European insurance sector Solvency II ratio is, on average, below 200%. Indeed, its estimated Solvency II ratio equivalent is about 300%, showing its superior capital position. This means that Swiss Re does not need to retain earnings to improve its economic capital position and therefore has plenty of room to distribute excess cash to its shareholders.
Swiss Re has a good dividend history over the past few years, delivering a growing dividend since 2010. Its goal is to have regular dividend increases, delivering an attractive shareholder remuneration policy. Its last annual dividend was set at CHF 4.60 ($4.53) per share, an increase of 8.2% from the previous year. At its current share price, Swiss Re offers a dividend yield of close to 5%. Like many European companies, its dividend payment frequency is annual, reducing a little bit its income appeal. Additionally, investors should take into account that the Swiss dividend withholding tax rate is 35%.
Even though the company has delivered a growing dividend, it still has plenty of room for further dividend increases. Its dividend payout ratio was only 35% in 2015, a very conservative level, taking into account its defensive business profile and superior capitalization. Swiss Re does not need to retain much cash and could easily have a much higher dividend payout ratio, at a level of about 60-70% of its earnings. However, considering the company's conservative culture, its dividend payout ratio should be between 50-60% in the next few years.
Additionally to dividends, the company also has a policy of returning excess cash in periods where losses are in line or better than average, supplementing its ordinary dividend with special dividends or share buyback programs. Indeed, more recently the company has moved to share buyback programs instead of special dividends, and its recent share buyback amounts to about $1 billion, to be completed by mid-2017.
Swiss Re is a company with a very attractive profile for income investors, due to its competitive advantages within the reinsurance industry, good capitalization and conservative dividend payout ratio. Its strong fundamentals enables it to provide an attractive and sustainable dividend yield over the long-term that also has good growth prospects, making it quite attractive for income-oriented investors.
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