"We are drawing a line under the burdensome issue of reserve strengthening at American Re," said Munich's Board Chairman Nikolaus von Bomhard, announcing a $1.4 billion increase in reserves for American Re. Together with $203 million in retrocessional exposure to Munich Re, the total strengthening amounted to $1.6 billion, or 1.29 billion euros, Munich reported in July.

The hit to Munich Re's second-quarter earnings, however, was only 388 million euros before taxes (roughly $488 million). Andrew Murray, London-based director for Fitch Ratings, explained that the actual impact of the reserving at the group level was smaller due to some allocations of incurred-but-not-reported figures.

According to Munich Re's financial statements, 906 million euros (or $1.1 billion), was already covered by IBNR reserves held at the group level, resulting in the 388 euro figure. The release of IBNR reserves, however, prompted Munich to recognize a deferred tax burden of 362 million euros--almost as large as the pre-tax charge itself.

The after-tax hit--750 million euros ($944 million)--lowered net profit to 182 million euros for the quarter, 72 percent below last year's second-quarter result. But Mr. von Bomhard said that even though the charges also pushed down first-half profit, which at 870 million euros ($1.1 billion) was 27 percent below last year's first-half result, a full-year return target of 12 percent is within reach.

"With the line we have drawn under American Re's difficult years, we have freed ourselves of a burden that placed undue strain on management, detracted from our successes and, not least, curbed development of our share price," he said in the August report to shareholders.

Last year's results also carried the burden of reserving issues at American Re, with a $422 million reserving action dampening overall profit numbers. Noting that $180 million of the 2004 reserving action stemmed from asbestos-related charges from decades past, Mr. von Bomhard addressed the situation in the annual report delivered in April of this year.

"The reserving requirements for these losses, which are dependent on the development of related claims complex in the United States, cannot be precisely quantified owing to numerous, constantly changing factors," he said.

But he held out hope that the class action bill steering more suits to federal courts would help out in that regard.

The balance of the reserve shortfall recorded in 2004 stemmed from 1997-2002 losses, which the chairman said the company was addressing by stricter underwriting from the home office and a reduction in maximum liability limits per risk in American Re's units.

Unlike reinsurers Converium and SCOR, which have chosen to abandon some of their U.S. businesses (see related article, page 17), when he announced this year's reserve charges in July, Mr. von Bomhard said Munich was "underlining its clear commitment to the U.S. market" with a capital infusion of $1.1 billion.

Founded in 1880 as basically the world's first separate reinsurer, Munich Re last year wrote $14.9 billion in property-casualty reinsurance premium. The reinsurance group as a whole posted a combined ratio of 98.9.

At Fitch, Mr. Murray noted some remaining issues facing the company, including capital management. That will be a key challenge for the company in the next few months as shareholders await either a dividend boost or buyback that could boost the share price, he said..

"The company has been focusing on reducing the amount of capital they require," he said. "They have been de-risking in essence. Quite a lot of their risk capital was taken up in concentrations they have such as a very large investment in Allianz."

The two companies, based within a stone's throw of each other, share a common founder and have always had close links.

But before any share buyback, Mr. Murray said the company will look to improve its own rating. "They will look at their own capital modeling, rating agency capital modeling and the regulatory regime in the future for reinsurers," he said.

In July, Fitch downgraded Munich Re's rating from "double-A" to "double-A-miuns," following the reserve announcement. Fitch has maintained a negative outlook since November 2003, due to concerns surrounding future earnings, particularly in relation to U.S. reserves and European primary operations.

Other companies, including Bermuda reinsurers and Swiss Re, also are facing the capital management issue, Mr. Murray said. "From our perspective, that is a good thing, because the last thing we want to see is there being too much capital in the industry because it means nobody gets a good return with the consequences coming back in several years' time and damaging companies," he said.

The abundance of capital, of course, stems from the solid market of the past few years, and any reduction would have to take into account educated guesses as to its durability.

Chicago-based Fitch Ratings analyst Mark Rouck said the unusually severe 2004 catastrophe losses helped slam the brakes on any expected softening of prices. In addition, memories of 1997-2001 years will help temper any reinsurers' desire to seek market share unwisely.

In addition, the January 2005 renewal season harbingers a year-end combined ratio of 95-96, Mr. Rouck said.

Munich Re is among the companies encouraging the new players in the emerging regulatory European Union reinsurance regime to consider diversification and size when looking at capital requirements in the future. For Munich Re, with a life operation about half the size of its p-c sector and operations around the globe, such factoring would have its advantages, Mr. Murray said.

Art caption:

Munich Re is not the only global reinsurer to sing the U.S. blues in 2004 and 2005. But unlike SCOR and Converium, which have chosen to abandon some of their U.S. businesses, Munich Board Chairman Nikolaus von Bomhard said Munich is committed to the U.S. market and its subsidiary, American Re.

"We are drawing a line under the burdensome issue of reserve strengthening at American Re."

Nikolaus von Bomhard

Chairman

Munich Re Board of Management

S&P Chart info:

Flag: Profits Lower

Head: S&P TOP 20 GLOBAL REINSURANCE GROUPS--Ranked by Net Reinsurance Premiums Written

Although only Converium and SCOR had lower positions on a net reinsurance premium ranking put together by analysts at Standard & Poor's for 2004, reinsurance premiums for the top 20 reinsurers as a group grew only 0.5 percent overall. Combined loss and expense ratios also worsened for the group, with only four of the 17 groups that reported these ratios posting improvements last year.

SOURCE: Standard & Poor's