Swiss Re AG (SREN) Earnings Call Transcript

Good morning or good afternoon. Welcome to Swiss Re's 9 Months 2022 Results Conference Call. Please note that today's conference call is being recorded. At this time, I would like to turn the conference over to John Dacey, Group CFO. Please go ahead.

Thank you very much, and good morning or good afternoon to everyone from me as well. I'm here with Thierry Leger, our Group Chief Underwriting Officer; and Thomas Bohun, the Head of our Investor Relations team. Before we go to Q&A, allow me to make a few quick remarks on the release we put out this morning. The third quarter has been challenging for our P&C reinsurance business. The reported combined ratio was impacted by Hurricane Ian, in particular, as well as prior year impacts. On the latter, Slide 4 of our investor presentation provides a breakdown of our year-to-date technical result from prior years. We have set up economic inflation IBNRs in our property specialty motor lines to reflect higher actual and expected inflation for both 2022 and 2023. These reserving actions were not new to Q3, but were less visible in the first half of the year due to offsetting releases in other parts of the reserves. We have generally acted to reflect the latest views on economic inflation whenever they have changed. The main single reason why the group's net year prior technical result turned negative in Q3 is related to a reserving update that we did for a large prior year aviation loss, where new information was received after the quarter end, which we nevertheless decided to include in our Q3 figures. Moving on from the reported P&C combined ratio to the underlying result. We expect the normalized combined ratio to have been a number of points lower than the 96.9% we posted for the quarter. We had seen higher attritional losses than expected already in the first half of the year and this continued into Q3. On top of that, we also saw a higher amount of midsized claims, some of which we would not expect to repeat in subsequent quarters. Nevertheless, our 9-month results means that we do not expect to achieve the better than 94% normalized combined ratio for the full year on P&C Re. On the positive side, Life & Health Re and Corporate Solutions had strong third quarters. Life & Health Re's net income of $219 million is above our normal run rate of $200 million per quarter despite some ongoing impacts from COVID-19, albeit at a lower and more manageable level. Life & Health Re is well on track to achieve its full year net income target of $300 million. Corporate Solutions achieved an impressive 92.9% third quarter reported combined ratio despite absorptions from Hurricane Ian and is well on track to achieve its less than 95% reported combined ratio for the full year. Importantly, the recurring investment yield of the group has started to increase materially. The fixed income and short-term investments book has seen a recurring income increase of more than $100 million in Q3 alone, and this trend will continue to support our earnings power. Our SST ratio was very strong at 274% midyear. The Q3 number is expected to be at -- sorry, to be modestly higher in spite of the loss in the quarter. This provides a very strong basis for our capital management priorities, which focus on profitable new business growth and an ordinary dividend that we aim to increase or at least maintain. We also include on Slide 8 of the investor presentation to remind you of the positive outlook that we have on our 2024 transition to IFRS. We now expect both a higher shareholder equity and higher earnings compared to where we are today under U.S. GAAP. As a result and despite the challenging third quarter, we have unambiguously -- we have an unambiguously positive outlook for the group. Two of our business segments are already delivering on their targets, while P&C Re is well-positioned to benefit from the significant dislocations in the reinsurance market at upcoming renewals. And with that, I'll hand back to Thomas to introduce the Q&A session.

Thank you, John, and hello to you from my side as well. [Operator Instructions]. So with that, operator, if we could take the first question, please.

Our first question comes from the line of Andrew Ritchie with Autonomous.

Two questions for me. First of all, just on the old topic of catastrophe loss budget. Clearly, you're running ahead of the budget year-to-date. I mean even if it's nothing in Q4, you'll end the year somewhat ahead. The industry sort of insured losses are running at about $100 billion or thereabouts right now. And that seems to be the kind of new expected normal run rate. If that is a sort of new normal, you're well ahead. So can you just help me reconcile those 2? Is this still sort of -- are you still seeing a bit too much from sort of non-peak areas in terms of cat losses? Or is this just simply an inflation effect which you think will correct out with pricing? So that's the first question. Second question on capital. I mean, we have four ways now of looking at your capital U.S. GAAP, SST, IFRS 17 and then rating agency, which is more of a mystery. It's very hard for us to assess really what the capital flexibility is, particularly with a view to growing exposure potentially in '23. Do we just completely ignore the GAAP performance? I ask it because when I look at what rating agencies are saying, they seem to be vacillating recently this week, they were talking about the impact of lower unrealized gains as having some negative effect on the industry. So how do you view it? Is it -- are you purely focused on the SST? Is that all that matters can we completely ignore the GAAP development?

Andrew, thanks for the questions. Let me try and give a shot on them. I'm guessing Thierry might also want to come in on the first one in particular. But on the cat loss, we have outside of Hurricane Ian taken some losses on what we would refer to as secondary perils during the course of the year. The response, I think, is -- we've reduced our exposure in lower layers and two convection storms, but we haven't eliminated it. I think it's impossible to eliminate it. But I think the world broadly and our clients specifically should expect that we will be looking to continue to move up in the layers on which we take risks, in addition to getting fair prices for the layers which we choose to write, and reduce even further the exposure to secondary perils that seem to continue to be underpriced at least in the current market. Now some of this may correct, and we'll see how far that correction goes. You referenced also the inflationary impact. I think one of the realities of our -- the loss we booked on Ian, which we do think is a prudential booking based on partial information that we had to -- you had at hand to utilize when we put the $1.3 billion up is that the inflationary impact on rebuilding on the wind damage of the cost of the motor losses is material compared to where we might have been 12 months or 24 months ago. And so these rates will also have to adjust for inflationary impacts on the cost of the damages and also on the asset values of the insured properties. And that's why we expect January 1 renewals, but also further renewals deep into 2023 to be of a material nature in terms of the increase. With respect to capital, I appreciate your question. I think first and foremost, you're exactly right. The SST basis and the underlying economic capitalization of the group are what's driving our decisions, both for capacity as well as for ultimately the capital measures that we choose vis-a-vis our shareholders. I think the decline of our U.S. GAAP shareholders' equity by about $10 billion during the course of the year is simply a mathematical reaction to the rise in interest rates. Those interest rates economically are beneficial to us unambiguously and will provide a material increase in the earnings of the group on a going-forward basis. The rating agencies, I think, are, as you say, a little mixed and the importance their placing on the reported GAAP equity, I do believe that they would have their models and run as they see fit. But from our point of view, the U.S. GAAP shareholders' equity is not at all an indication of the resilience or the risk capacity of the group. And we noted, we pay attention, obviously, to the rating agencies and their concerns, but at the end of the day, we will make decisions on to write business or not write business based on underlying economics. The last piece on IFRS, just to reiterate, we've included a slide in the deck, without numbers, these are modeled, but we actually think our modeling is both accurate and the direction of the relative blocks that you see is clearly indicative of the actual expectations for how shareholders' equity, the CSM and the risk adjustment might play out on our balance sheet when we go live in 5 quarters from now. And so in that context, I'm confident that this better representation of the economic reality of the group will be much more transparent. We can drop the U.S. GAAP view and at least simplify your life a little bit. But maybe, Thierry, anything to add on the first part?

Actually, maybe one thing because there was a lot of emphasis that you put on inflation and on secondary perils and time change. I think we have been quite consistent in the message that actually most of the increase in our natural peril exposures are coming from urbanization and increase in wealth. And obviously, now the inflation adds to it. And climate change has been a minor driver of that. And as we have repeatedly said, climate changes, however, a bigger driver for the secondary peril. So for example, TCNA, the recent Ian event TCNA is not driven by climate change, but hail in France is partially driven by climate change. So we have to differentiate all this. And the question of the $100 billion is for us, an obvious one, we absolutely believe that just generally, the loss load for the industry is increasing. And what is important to us is, what is climate change driven in that increase, and make sure we have that correctly modeled. So that's what I wanted to add.

The next question comes from the line of Freya Kong with Bank of America.

Two questions, please. So first question, at half you indicated that you would have expected the P&C Re attritional loss ratio to step down quite a bit in H2 due to business mix changes. And I think at the time, you said around 3% improvement, H2 versus H1. We've not really seen this play out. And I guess, what's happened between then and now for such a meaningful deterioration? How much of this was inflation driven versus higher frequency that you expect could reverse? Second question is, you've made some IBNR provisions for short-tail lines and property, specialty and motor. But U.S. liability reserve strengthening is of a similar magnitude to prior periods. What's your view on higher economic inflation trickling into longer tail liability lines? Has this happened yet? And what are your expectations here?

I'll take the first one, Freya; and John the second. So you're absolutely correct. We were expecting for the third quarter lower attritional loss by several percentage points. And this is driven by seasonality in our nat cat budget. So we expect more nat cat business premium to roll into Q3 and accordingly because that business has a lower combined ratio. We also expect a lower combined ratio or the attritional loss ratio for the third quarter. So we had already observed and have been also clear on the fact that in the previous quarters already, we had a higher attritional ratio than we actually wished. So we have also -- I have been very clear that we are not satisfied by this. And clearly, we were very clear that we will not rest in underwriting, improve structures, terms, conditions, price until actually the attritional loss ratio is coming down. Now the fact that we have missed it by even more in Q4 is, to me, a mixture of that what we have observed in prior quarters not been resolved yet, plus, of course, a higher inflation than we expected. And then we had a higher frequency of losses between $10 million and $20 million that I would see rather as a one-off statistically absolutely possible to have, of course -- where we just have more of those losses. So as a result, what we read into the attritional loss higher than what we want is that we continue to be under pressure to improve the terms, as I said. And as I also said, is that we have dramatically reduced our observation period that before it was like 10 years now, it's 3 to 5 years, so we can now, of course, see in our calculations, these elements of higher attrition as coming into our burning rates as well. And as a last point, you remember in July, we had this plus 12, minus 12, these two numbers out there. So the price up 12 -- nominal price up 12 and loss costs down or up 12, and I do remember having had some discussions with some of you and you ask me, isn't it a bit conservative. And as we can see now, it turns out it wasn't. Maybe the numbers should rather have been plus 14, minus 14 at hindsight, obviously, we always know better.

Thierry, just for the absence of doubt, I think to be clear, we saw in Q3 this spike in some one-off losses that we wouldn't necessarily expect to continue in Q4. And so while we expect our normalized combined ratio in P&C Re to reduce in the quarter, it's highly unlikely to reduce enough to get us back to the 94% for the full year. So that's a starting point. I think on the inflation vis-a-vis liability and long-tail lines, our observations to date is that any CPI related inflation is overwhelmed by the social inflation and other factors, which is driving up loss costs for these liabilities portfolios. And what you saw on Slide 4 of the deck we provided was material increases in these reserves over the last 3.5 years to get to a position which says we believe we're well-reserved for the impact. That Q -- or 9 months of 2022 doesn't necessarily have the kind of very specific CPI inflation, but the overall increases we make are related to what we think are ultimate loss costs. So could there be subsequent impacts, possibly. But I think what's more important is we get it right, vis-a-vis both the existing reserves, but more importantly, the costing for new business. We continue to write liability lines, and we need to be sure that were charging adequate rate to cover what is a challenging environment, especially in the United States liability book where we're not the only ones that are, I think, noting that there's no indication that social inflation is reducing any time soon.

The next question comes from the line of Will Hardcastle from UBS.

Coming back to a couple of questions as you are already asked, just extrapolating a bit. I guess trying to work out that starting point for our normalized really for the year. Obviously, you're not going to achieve the 94%. You've been very clear on that, but that's cost some one-offs, as you call it, within that. Should that still be the starting point for how we're thinking for beyond '22? Or do you think there has been a structural aspect that means that 94% was a bit too optimistic in light of a lot that's changed this year? And second, coming back to Andrew's question on the credit rating agency capital. Is it fair to say this is currently the binding constraint for you at present? Or would you be willing to effectively challenge rating agencies, grow exposure significantly, because your economic models differ so much from the rating agency model. And what would be the impact on the business, should you challenging too far, obviously, a downgrade might do, and also presumably seasons would challenge this view, I guess -- I'm trying to understand if that's the binding constraint and how close we are and whether you'd be willing to go against it.

All right. Well, let me give you a shot. On the normalized combined ratio, some of the adjustments that we've made on the APLRs for business written in the second half of last year, this year for '20, but earned in 2022 reflect an inflationary environment, which was not necessarily transparent when we set these initial goals. I do think -- and Thierry mentioned the January 1 renewals of nominal prices up 10%, loss costs -- up 12%, sorry, and loss cost is up 12%, which reflects the reality that we saw at midyear. My sense is pricing across every line of business for reinsurance is going to go up, exposures are going to be structured. Terms and conditions are going to be tightened. And as a result, I think it's premature to put out a target for 2023, but I don't think it's a valid expectation to say that normalized combined ratios will go up. It may well be the case. The price impacts are sufficiently strong that will give us a higher degree of comfort and capability of achieving something like 94% that we're just going to have to wait until we see the dust settle on these renewals. So that's the direction I can go there. With respect to capital, we've got no particular interest to challenge the rating agencies. We do have a frustration, I can say that the direction of our regulatory capital moves absolutely in opposition to the direction of our U.S. GAAP shareholders' equity which is the basis for at least one of the rating agencies models when they start assessing available capital. And that frustration is not going to be solved anytime soon as we indicate, we believe that as we migrate from U.S. GAAP to IFRS, the rating agency has got a bit of a helping hand to be on a more economic framework than their starting point is today. I don't think even with a stronger -- actually, a very strong price movement on many of our lines of business that we're necessarily going to be growing our exposure dramatically. We may be growing some parts of it where the pricing is unambiguously attractive. But I think overall, we will be cautious in going too far out with growth at the beginning of the year. We've seen the losses that have come through. We believe in our models, but we don't see the need to take outside risks in spite of having an SST ratio of 2.74 at midyear. So you can expect us to grow parts of the portfolio, the sort of FX adjusted a 9% growth you saw in CorSo, I think you should expect to continue in the commercial lines and P&C Re. We'll see where the prices -- our clients are willing to pay, and the terms and conditions and layers, which they're willing to accept. And based on that, we'll see how much capital we actually deploy. But again, it's not a matter of challenging the rating agencies. It's a matter of trying to work with them to be sure that they understand our view is the economic view, and we believe that we are well-managed on that basis.

Your next question comes from the line of Kamran Hossain with JPMorgan.

Two questions. The first one is on, I guess, looking at the -- two questions from me. The first one is on the renewals in January. When you think about those, we're seeing some messages in the press. Can you maybe give us an idea whether you're planning to kind of grow, kind of increase exposure ahead of inflation, also perhaps kind of improve the quality of the portfolio in reinsurance? And the second question is on alternative capital partners, which has become, I guess, an increasingly kind of important part of the business in recent years in terms of the way that it can support the reinsurance business. Can you just an idea of, firstly, how well have investors done that have kind of been in ACP? And what do you think the appetite is for them to continue to support you into '23 and beyond?

Kamran, I'll take the first one. So with regard to 1/1, I guess everyone recognizes that the reinsurance industry has been through several difficult years. We just have to remind ourselves of the liability losses. John did before, but also on the cat side, secondary perils and so on. So what we have seen this year was that the demand was outstripping the offer. So on the capacity side, we have seen some reduction in capacity. And on the demand side, mainly driven by inflation, yes, seeing the demand going up. What's going to happen, in our view, on 1/1 is that the demand will go up further fueled by even higher inflation, and we see that the offer is even additionally under pressure. So in my view, I wouldn't be surprised if we went into a gap for, for example, [T&A] of $20 billion to $50 billion for the industry, which would be 10% to 20% for the industry. That will be very, very significant. So for us, that's therefore, an opportunity, as John pointed out already to do three things. So we look at price, we look at structures, so retentions mainly, and we look at the terms under which we ensure these. So it's going to be very clear that we will be more than ever focused on our sweet spots in terms of where we play. So very generally, we think that the retentions will move up. We will certainly push for that. By moving up the retentions, we will remove ourselves from secondary perils again in an even bigger step than we have done this year, and we will tighten the terms, as I said. And we see, obviously, because of the higher demand, significant improvements on the price side. Your question with regard to risk adjusted, it's a difficult one to answer ahead of the renewals because the renewals with our clients are still ahead. So we will certainly very, very carefully choose our loss picks and include a net conservative view as we can on loss trends generally, but also inflation, secondary perils and everything. And I'm actually very, very confident that we will be able to achieve price improvements beyond the adjusted loss pick. So we should next year clearly see risk-adjusted price improvements. But again, discussions are ongoing but the first signs are positive.

Would be anecdotal, if I would add to that is I think the primary market understands that there may be a dearth of capacity out there and as opposed to the end of 2017, into the January 1, 2018 renewals where people are willing to wait till the very end on December 31, and in some cases, found capacity from people diving in. I think that there's a clear expectation that moving earlier to secure capacity even at much higher rate is probably in the interest, and that's what we've already seen anecdotally happen. And I think it's just a very different environment than what you saw any time in the last decade vis-a-vis the imbalance between supply and demand. On your second question, vis-a-vis the alternative capital partners, this team continues to do well and securing capacity. We're not dependent the way some other market participants might be on retrocessions. But what I can say is the alignment of interest between the group and these partners and the transparency, we've been able to provide on losses has served us well. And I believe we've got about USD 3 billion of capacity that's -- or assets under management in this space in addition to another billion or so on matter on Re, bond programs were very comfortable that we've been treating our co-investors well, I think the underweight exposure that we've been able to show on the Florida law suit is an example of that, and we will continue to work with potential investors who are willing to stay with us over time. So it's been a good story for us.

The next question comes from the line of Vikram Gandhi with Societe Generale.

It's Vik from SocGen. A couple of questions. Firstly, some thoughts on where the group is with the inflation topic after this inflation IBNR and where the group is with this annual reserves review? And why the group's reluctance to invest in inflation linkers over the past 3, 4 quarters when there was quite a bit of foresight that inflation could become an issue? That's question one. Secondly, I see the encouraging comments on higher recurring income, but it looks as though most of it is coming from yield pickup at the short end of the curve. Now when I look at Slide 14, I still see the liquidity at exactly the same level as at year-end '21, that's $13.5 billion. So the question really is why isn't the group trying to lock in higher yields on the long end?

I'm happy to address both of those. With respect to inflation, we've evaluated both 2022, but also 2023 current expectations, the Swiss Re Institute runs their own. You won't be surprised if they're not too far away from where consensus -- market consensus would be. And we've addressed the positions quarter-by-quarter, as we've indicated when the new information comes out. And at least for the moment, those quarterly updates have resulted in higher expected inflation for longer than what might have been the case at year-end 2021. But even there, we started to put some of the reserves up. With respect to the inflation linkers, we've never said we don't have any -- they don't flow directly through our P&L the way that they might for some of our competitors. But the concern I think we've got is the basis risk, and frankly, the other somewhat odd performance of these bonds in volatile markets. And so they've not struck as a great hedge necessarily against the kinds of inflation, whether it's CPI, the specific parts to the construction industry or motor market wages of medical that we have exposure to through our claims position. So while directionally, they might be helpful, I'm not sure that they always behave in ways which are going to really solve your problem that we see. But again, it would be wrong to assume we don't have any in the asset portfolio. On your second question of the liquidity, yes, when you're looking at an inverted yield curve, it's a little tough to say it's the moment to go long because rates are going to be falling and so we should capture in a particular moment where the 10-year is paying before it drops down. I think you're right, we have been taking advantage of a much higher yields on the shorter end. And our team is evaluating constantly how far out to go based on a view of the downside risk of locking in to rates, which might 12 months from now appear to have been 100 basis points, 150 basis points lower than what might be available in the future. So it's not an easy call, but at least for the moment, I think we're pretty comfortable capturing the yield pickup. And if we have a different view, we'll adjust the positioning appropriately. We do have the constraint of largely matching the duration of assets and liabilities and not being able to go either too short or too long across any of these positions in the curve.