Munich Has Developed a Unique Approach to Carving Out a Competitive Position in Certain Lines

Equity Analyst

Henry Heathfield

Munich Re is the largest reinsurance company in the world, yet that size has its drawbacks. We think the company has some really nice and moaty business lines, that seem almost unrivaled, yet the impact that those lines can have on the overall business is not enough to sway it into moaty territory. Munich has a strategy to drive growth in its Global Specialty Insurance and cyber lines. In the context of the property and casualty reinsurance division, gross premiums written in these two lines are growing faster than the underlying traditional reinsurance. Munich’s expansion of an inspection-based model combined with insurance yields superior underwriting results, in our opinion. And we believe its traditional area of expertise in providing these inspection-based services utilizing historical records and specialized industrial engineers is probably the most moaty way the business has been able to develop good underwriting earnings. There are likely underwriting benefits to be had in developing that model into the Internet of Things. We think Munich is one of the few reinsurers developing specialist insurance and reinsurance with this combination. However, when we think more broadly about the competitive dynamics of that approach versus an engineer-based model, we think the new IoT model holds lower barriers to entry and is more replicable. While Munich may be able to gain insights from these peripheral technologies and may have a first-mover advantage in rollout and integration, we see little reason another reinsurer could not replicate this. We think a purer focus on research and development of proprietary technology would be a more durable way to develop an underwriting-based competitive advantage.

While we like Munich overall, we are less keen on the attachment of a primary insurance division. We think developing a competitive advantage in underwriting large reinsurance, corporate, and specialty risks is different from developing a personal lines-based competitive standing. The addition of a personal lines business therefore muddies the ability to carve out a larger loss exposure-oriented, maintainable competitively advantaged position.

Business Strategy & Outlook

We award Munich no economic moat. While we believe Munich’s Life and Health reinsurance business, and its primary insurance business, Ergo, do not generate economic returns, we believe Munich’s property and casualty reinsurance business does.

We think Global Specialty Insurance operates with some competitive advantages. The division houses a number of smaller businesses. We think it probably accounts for around 23% of total property and casualty reinsurance gross written premiums, and that contribution has grown substantially, by almost threefold, over the last 15 years. Including facultative and cyber, we anticipate moaty business lines contribute around one third of property and casualty reinsurance gross written premiums, and that will likely grow to a little under half over the next 10 years. These business lines are largely detached from the reinsurance cycle, so profitability is at more stable levels.

The American Modern business was founded in 1983 initially as a specialty primary lines insurer across three main lines: residential property, recreational products, and financial institutions. Residential property insurance is sold for manufactured and site-built homes constructed on the landowners’ land. Recreational insurance is insurance sold for motorcycles, collector cars, and watercraft. Insurance sold to financial institutions is lender-placed property insurance when the borrower falls into default. We believe American Modern has a market position of around number 25 across all U.S. home insurers, partners with insurance carriers that cover around 40% of the U.S. market for primary lines, and operates with low-90% combined ratios.

We think the most interesting business within Munich’s Global Specialty Insurance business is Hartford Steam Boiler, or HSB. Founded in 1866, this business has three main product lines. In equipment breakdown, the company provides inspection and loss prevention services. Other specialty products insures against events such as data compromise, employment practice liability, and identity recovery. In engineering, the company provides ASME code certification and loss prevention services. Code certification services verify that products meet the required set of standards for quality, reliability, and safety, and 80% of fee engineering sales are sold directly to customers. According to filings, HSB is the largest ASME inspection services provider, with a 40% market share, and it also benchmarks the operating performance of 80% of the world’s oil refining plants.

The origins of the business lie in the Industrial Revolution when boilers were used to drive industrial steam power. As some boilers began to explode, an inspection service was needed. HSB established an integrated boiler inspection and insurance service, that Munich still broadly pursues today. The rationale for this integration is that inspections increase boiler safety and insurance provides an incentive for inspection services to be provided in a high-quality way. This integrated system is now applied beyond boilers to water supply systems, industrial heating and cooling systems, electrical power, refrigeration, and telecommunications. We think the proprietary knowledge and complex engineering expertise required to operate here successfully have created high barriers to entry. We think HSB's combined ratios are between 80% and 85%.

We think Munich Re has used its HSB business to drive its industrial and Internet of Things strategy. A good early example of how Munich has built and applied this is the business’ early solution for places of worship. Some years ago, one of Munich’s primary insurance clients was having an issue with insuring places of worship. This was because during the winter months when these buildings were often vacant during the week, the drop in temperatures would lead to burst water pipes, and that would subsequently lead to claims made to the primary insurer in order to repair the pipework and clean up the mess. Munich’s solution was to install water monitoring equipment that could be remotely monitored and provide the user with alerts when relevant. This approach was initially piloted in 20 buildings of worship, then another 250, then due to its success 10,000 were scheduled over a three-year period. This system substantially reduced the frequency of these claims, and when they did occur the speed of an alert and response quickly helped to limit claim severity. The primary insurer paid for the cost of the equipment and monthly monitoring fee, and Munich provided a warranty on the exposures.

We think this experience has been the basis on which Munich has developed its industrial IoT strategy, serving companies with integrated testing technologies and IoT solutions. For example, Munich now provides customers with real-time production dashboards that enable the user to remotely monitor, optimize, and control production. Sensing equipment can make automatic adjustments within the production line, and these same sensors can monitor the condition and health of the machinery and equipment. This means they can predictively schedule maintenance, limit downtime, and increase production. HSB's expertise in testing and certification also means that in some cases IoT production line equipment can provide quality control and regulatory reporting. We think a good example of this is Munich’s automotive sector partnership with MHP and KUKA, MHP being a subsidiary of Porsche. Munich has also entered into a partnership with Trumpf. Results include reduced downtime, increased productivity, improved quality, lower costs, and higher flexibility. These outcomes mean Munich can provide integrated solutions for monitoring and testing as well as insurance services.

We think Munich has started to leverage these capabilities across property and casualty reinsurance. It uses a state-of-the-art data and analytics system Munich Re Data Lake, 150 full-time data scientists, and insurance-specific artificial intelligence to drive similar improvements within broader traditional reinsurance. By using historical claims data combined with weather and geospatial data collected by fixed and aerial sensors, Munich can work toward predicting and preparing for the outcomes of insured events. Based on historical growth rates, we think Global Specialty Insurance can account for one quarter of Munich’s property and casualty reinsurance premiums by the end of 2025. Munich is also establishing an additional board division to solely focus on Global Specialty Insurance, with the target of this division accounting for 30% of overall property and casualty reinsurance gross premiums written by year-end 2025. Management newly targets a maintainable return on equity of 14%-16%.

None

Economic Moat

Muenchener Rueckversicherungs-Gesellschaft AG in Muenchen

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Münchener Rückversicherungs-Gesellschaft AG engages in the provision of insurance and reinsurance services. It operates through the following segments: Life and Health Reinsurance; Property-Casualty Reinsurance; ERGO Life and Health Germany; EGRO Property-Casualty Germany; and ERGO International. The Life and Health Reinsurance segment includes global life and health reinsurance business. The Property-Casualty Reinsurance segment covers global property-casualty reinsurance business. The ERGO Life and Health Germany segment includes German life and health primary insurance business, global travel insurance business, and digital ventures business. The EGRO Property-Casualty Germany segment covers German property-casualty insurance business, excluding digital ventures business. The ERGO International segment focuses on primary insurance business outside Germany. The company was founded by Carl von Thieme on April 3, 1880 and is headquartered in Munich, Germany.

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