EUR 850.00 For Business Accounts Only

Morningstar | Disappointing Nine Months for Hannover Re; Shares Overvalued

Hannover Re reported nine-month net income of EUR 725 million, EUR 170 million for the third quarter. Much the same as Munich Re on Nov. 7, we are not overly impressed with these results. They just plainly look light given the natural catastrophe environment, and while tougher, though nowhere new hard enough, comparable period. We're going to maintain our fair value estimate, which was already a 10% discount to the market. Granted, Hannover Re earns more than its cost of capital, which is rare in the insurance industry, and this is a quality franchise. However, the over 1.5 times book value is not justified by the excess earnings differential. We also maintain our narrow moat and stable moat trend ratings.

While the headlines coming out of the business are clearly "heavy large losses" related to typhoons Jebi, Prapiroon, and Trami in Japan and Hurricane Florence in the United States, the large loss for the quarter only came in at around 450 basis points. While this isn’t comparable to the 13.2% last year, which wasn’t a big year for events, in our opinion, it is still significantly lower than better-performing underwriting years. Fundamentally, to us, this is a bit of a letdown in property and casualty.

As we discussed in our Munich Re results note, we think this comes down to greater active involvement in more midsize risks, as the pricing environment has remained challenging. However, we find this approach a little wet to say the least. Clearly, alternative capital has been dampening the market for some time, but pricing has shown signs of turning, albeit very slowly. The problem with sticking to these midsized risk is that pricing does not move strongly enough after an event. So it seems to us that in a soft environment, mediocre results will continue. By focusing on the higher-risk exposures, when pricing is starting to move, the upswing for these businesses will be greater, albeit with some short-term pain on results. We have generally found Hannover Re to be one of the best-run reinsurance businesses. But if, what we think what is, a continued focus on mediocre exposures remains, we believe the business performance and reputation will suffer long term. Primaries turn to these companies for expertise. And that is less specialized the further down the value chain you travel.

Life and health, as we have repeatedly discussed, continues to be plagued by 2009 United States mortality. Again, this is a disappointing EUR 64.2 million operating profit negative. As a result of announced rate increases, some of Hannover’s clients exercised their right for treaty recapture. So in essence, what is happening here is the business is trying to offset poor profitability on this 2009 U.S. mortality book by increasing pricing. But doing so causes some previously ceded business to be brought back. This has resulted in a one-time charge of EUR 218 million, or $260 million, this period. This is assumed to rise to between $350 million to $400 million for the full year. While it is fair to say that the recapture will be mitigated in future years by the lower claims coming off this book, we just really want to see the business settle this. The 2009 U.S. mortality problems have been dragging on for some time, and management has previously assured the analyst community that these issues have been resolved. While we were skeptical at the time, and voiced this, our patience is wearing thin.

Return on investment was decent at 3.3%, above the 2.7% target, and a continued improvement. This was driven by income from private equity and real estate.