Munich Discusses Investment Loss Spiral

Despite the collapse in the companys equity holdings, primarily in the German market, Mr. Booth said Munich Re plans to ride out the storm.

"Munich Re has suffered clearly from World Trade Center claims as well as the need to substantially top up its American Re reserves, which has meant that its lost money on its reinsurance business very substantially in the last two yearsas indeed have most other reinsurers," said Christopher Hitchings, analyst for Commerzbank Securities in London.

"Munich Re is also a substantial equity investor and a substantial German equity investor," he added. German equities performed even worse than most equities, Mr. Hitchings said, and Munich Res three largest investments have been among the worst performing German equitiesAllianz, HypoVereinsBank and Commerzbank.

In terms of losses, the biggest problem for Munich Re has been the German banking sector, which has suffered from a weak German economy and considerable loan loss provisions, he said.

"Further," he added, "the German banking system has traditionally operated on the basis of taking considerable equity stakes in customers, and the substantial decline in the German equity market has therefore again substantially reduced the banks capital."

Adding to the problem is that Munich Re has a 26 percent stake in HVB at the same time its largest investmentAllianzowns 100 percent of Dresdner Bank, Mr. Hitchings explained.

Creating a three-way spiral is the fact that HVBs share price has been hit due to its 13 percent stake in Munich Re and its 5 percent stake in Allianz, he said.

"Fears that it will be forced to rescue HVB, on top of its own balance sheet problems, are behind the relentless decline in Munich Res share price," said Commerzbank Securities in an insurance news briefing issued on Jan. 31, 2003.

"Year to date, HVBs share price is down 40 percent," said Mr. Hitchings, and the bank announced a fourth quarter loss of 800 million euros ($859 million).

"At the moment, this shareholding [in HVB] within the framework of our overall asset mix is very small," asserts Mr. Booth. "Its a small issue now" because the bank is worth a lot less than when Munich Re increased its stake in HVB in 2002 "to be fairly blunt."

"We had 25 percent of a bank that was worth 20 billion euros [$21.5 billion] market capitalization and now the same bank is worth just under 10 billion euros [$10.7 billion]," he said. "We ran the risk and we allocated capital to that risk, and now its run its course. There is no pressing reason why we would want to sell down [the stake] because, in economic terms, its not an issue to the Munich Re," Mr. Booth said.

He said Munich Re could have sold out of HVB at the bottom of the market, but then, when the upside eventually comes, the company wouldnt have had the benefit of the HVB bank distribution network. "Looking at equities generally, although they are vast underperformers at the moment, our thinking is not to throw out the baby with the bathwater," he said.

David Wharrier, director, insurance group for Fitch Ratings in London, indicated the asset picture for Munich Re is not as dire as it may appear. The reduction in asset values has simply reduced the cushion of "hidden reserves" that Munich Re once held because theyve always been classed as off-balance sheet gains, he said.

The decline in Munich Res asset position is having less of an impact on its balance sheet and its regulatory return than it is on the view of Munich Re as "this historically super-overcapitalized group."

"Theyve always had this super cushion, which has now taken a significant hit," he said. "Now they are realizing, as a management team, theyve got to deal with what every other group has to deal with, which is managing capital effectively and getting the best returns in the product lines in the countries that theyre underwriting in."

Further, its possible that there would be some state assistance for HVB if that is needed, which may take the heat off Munich Re, said Bridget Gandy, managing director in financial institutions group of Fitch.

Reproduced from National Underwriter Edition, March 17, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved. Copyright in this article as an independent work may be held by the author.