Hannover Re’s Diversity Plan Set to Boost Shares; Weather Worries

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The short-term success of Hannover Re’s bid to diversify away from risky businesses is hostage to the hurricane season, while further out, it is likely to lead to a positive re-rating of the shares.

The world’s fourth-biggest reinsurer’s new chief executive has promised a more conservative underwriting and investment policy to reduce wide earnings swings and lure shareholders.

“We are continuously undervalued because investors are unsure about future profitability,” Ulrich Wallin, who took the helm at Hannover Re on July 1, told Reuters in an interview. “We now want to stabilize earnings,” he said.

The company intends to rebalance its business by achieving an even split between life/health and non-life reinsurance over the next five years, boosting the share of life and health premiums from around 42 percent this year, while trimming non-life, now at around 58 percent of gross premiums.

The key risk is that Hannover Re is writing less high-margin natural catastrophe cover in part because of the rising cost of retrocession, or the passing of some risks to other reinsurers.

Foregoing some high-margin “nat cat” business is part of the price of rebalancing the underwriting book for more stability.

“Hannover Re have seen that they can’t survive just on a diet of caviar. They have to eat vegetables, too,” said JP Morgan analyst Michael Huttner.

The new diet could prove bitter if 2009 turns out to be a mild year for hurricanes, as many predict. “We are passing up about €40 million [$55.88 million] in profit this year because we placed less retrocession than we planned,” Wallin told Reuters.

But the lack of available retrocession could also be trouble if hurricane claims turn out to be above average this year, because Hannover Re is keeping more risk on its own books.

“We think that the earnings risk is higher than at peers Munich Re and Scor due to increased retention,” said JP Morgan, which has an “underweight” rating on Hannover Re.

LONGER-TERM REWARDS
While the plan may dampen earnings and dividends in the short term, analysts and investors say it’s the right direction to take.

“Over the last five years, expected profit was higher on average than the actual, either because there were bigger loss claims from natural catastrophes or because investments suffered in the market collapse,” said DZ analyst Thorsten Wenzel.

UniCredit analyst Bernd Mueller-Gerberding agreed. “There has been a discount in Hannover Re’s valuation up to now because the company is less diversified than others and sometimes took on high risks, such as in natural catastrophe reinsurance,” he said.

According to StarMine, which weights analysts’ forecasts according to their track record, Hannover Re trades at 5.4 times 12-month forward earnings, a discount to rival Munich Re’s multiple of 7.4 and Swiss Re’s 7.9.

Hannover Re’s share has risen by 3 percent so far this year, while Munich Re is down 15 percent and Swiss Re nearly 40. The DJ STOXX European insurance index has fallen more than 15 percent year-to-date.

Norway-based Skagen Funds manager Filip Weintraub said Hannover Re held an advantage over the bigger diversified reinsurers because it was better able to chop and change, exiting any business it found unprofitable.

Wallin’s team is becoming more active in credit and surety business just as others, such as Swiss Re, are cutting back.

“Hannover Re has the track record to back its strategy,” said Weintraub, adding that the company’s plan was being put in place for positive reasons and not due to financial stress.

Hannover Re accounts for €50 million [$69.87 million] or 1.4 percent of Weintraub’s Skagen Global portfolio. “They are very pragmatic about writing business,” he said, adding that he had increased his holding of the share in the second quarter. “Hannover Re should be worth €35.00 [$48.90] per share,” he said.

The share was trading at €23.55 [$32.91] late on Friday.

(Editing by Sitaraman Shankar)