MURGF - Münchener Rückversicherungs-Gesellschaft Aktiengesellschaft in München (MURGY) CEO Joachim Wenning on Q2 2022 Results - Earnings Call Transcript

Münchener Rückversicherungs-Gesellschaft Aktiengesellschaft in München (MURGY)

Q2 2022 Earnings Conference Call

August 9, 2022 8:00 AM ET

Company Participants

Christian Becker-Hussong - Investor Relations

Joachim Wenning - Chief Executive Officer

Christoph Jurecka - Chief Financial Officer

Conference Call Participants

Will Hardcastle - UBS

Andrew Ritchie - Autonomous

Freya Kong - Bank of America Securities U.K.

Kamran Hossain - JPMorgan

Ivan Bokhmat - Barclays

Iain Pearce - Credit Suisse

Vinit Malhotra - Mediobanca

Darius Satkauskas - KBW

Ashik Musaddi - Morgan Stanley

Derald Goh - RBC Capital Markets

Thomas Fossard - HSBC

Dominic O'Mahony - BNP Paribas Exane

James Shuck - Citi

Vikram Gandhi - Societe Generale

Presentation

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. My name is Rensi, your Chorus Call operator. Welcome, and thank you for joining the Munich Re Half Year Financial statement as at 30th June 2022. Throughout today’s recorded presentation, all participant’ will be in a listen-only mode. The presentation will be followed by a question-and-answer session. [Operator Instructions]

It is my pleasure, and I would now like to turn the conference over to Christian. Please go ahead.

Christian Becker-Hussong

Yes. Thank you, Rensi. Good afternoon, everyone. Warm welcome to our Q2 earnings call. I have the pleasure to be in the room with our CEO, Joachim Wenning; and our CFO, Christoph Jurecka.

And the procedure is straightforward. There will be an approximately 15 minute introduction based on the slides we have put on the Internet this morning from both of the gentlemen and then we can go right into Q&A, as always.

And it's now my pleasure to hand it over to Joachim for his introduction.

Joachim Wenning

Thank you, Christian, and colleagues, good afternoon also from my end. I'm on slide four. Munich Re achieved a pleasing first half 2022 result, despite significant geopolitical and macroeconomic challenges imposed by the war in the Ukraine and a sharp rise, of course, of inflation levels.

Based on very sound underlying performance in our core business, we stick to our full-year profit guidance. We have taken advantage of the hardening market and have profitably grown our business. And after severe hits from COVID-19, the results in Life and Health Re impressively recovered as seen in the Q2 results. ERGO is almost like a clock work delivering on its targets quarter-by-quarter. And I should also mention risk solutions in that regard as these businesses are performing pretty well and will facilitate increasing stability of our overall earnings profile going forward. And after all, I'm grateful for higher interest rates as these will gradually increase our sustainable investment results.

Moving on to slide five. I mean, Christoph will provide you with more detail on our half year results, but please allow me to highlight a few things only that matter to me. We are in a great market environment as insurance rates are much more attractive than they used to be some time ago. In P&C Re, we grew our business by almost 19%, while at the same time, improve margins with a combined ratio of almost 4 percentage points better than in the first half of last year. This helps us compensate for the impact of extremely volatile capital markets with turmoil in the equity and credit markets, as well as sparking interest rates.

Considering currency, which as an asset class is not reflected in the investment result, I deem the return on investment quite decent. In essence, after the first half of the year, strong technical results across all lines of business delivered promising returns, which put us well on track to achieve our 2022 targets.

Next slide, and coming back to the key challenges the insurance industry is facing these days. Record high inflation is definitely the most imminent topic, especially for the back book. On the one hand, Munich Re is known for its prudent reserving and holistic ALM approach to mitigate these risks. On the other, we have seen significant nominal price increases in this year's renewals which were, to a large extent, driven by inflation and will be supportive for a continuation of the hardening market. With a certain time lag, interest rates responded to higher inflation. Economically positive for us, we have to live with some temporary accounting mismatches, which can affect IFRS earnings quite significantly.

First indications point to increase recessionary risks as high inflation, more and more affects consumer sentiment and spending. From our experience of last recessions, we would expect positive, as well as negative effects on our business, which might largely balance out. With comparatively low credit risk in our investment portfolio, I feel relatively comfortable. Experience also tells us that past economic downturns also provided business opportunities, for example, capital relief transactions. And the last topic, of course, is climate change. Munich Re is in a strong position to manage climate-related risks and related nat cat volatility, while taking advantage of business opportunities arising from the protection gap.

Let's take a closer look at inflation on slide seven. The good message is that a large part of our business portfolio is hardly affected. So the issue is pretty much centered on P&C Re, in particular, on the back book. And if you look at the maturity structure of our reserves, about three quarters is short-term business, while we can swiftly adjust prices to inflation development, more than 50% of our reserves have a maturity of less than two years. For long-tail lines, we prudently assess various inflation drivers that are relevant for each line of business. We have further strengthened our reserves to react to inflationary trends already last year. We feel that our solid reserve position provides quite some resilience to inflation developments. So although inflation pressure has increased, no doubt, we expect this risk to be manageable for us.

Slide eight. In the July renewals, in-depth investigation of business-specific inflation impact played a big role. Some parts of European and North American property business are now expected to be more exposed to inflation than before. Among the drivers for this is that demand for building materials currently exceeds supply by far, leading to strongly increasing overall building costs. Hence, a large share of a significant nominal price increases we have seen in the market, was mitigated by adjusted loss expectations. Overall, we have seen a continuation of the upward price trend as high loss experience and inflationary pressure enforced the need for adequate margins.

At the same time, we continued to choose increasingly cautious loss picks for long-tail casualty lines taking account of social inflation trends. Hence, the flattish price development we are showing is, as usual, prudent and fully risk and business mix adjusted. And our growth was quite selective to preserve profitability.

Referring to slide nine, there are discussions if the surge in interest rates is good or bad for insurers, that because a large share of valuation reserves is washed away, good because higher reinvestment yields are positive for future investment results. We're looking at the Solvency II ratio, which has noticeably increased, it becomes very obvious that rising interest rates are economically beneficial for our business and for our financials. In particular, our German primary life business benefits disproportionately.

So strategically, higher interest rates improve the quality of our investment result as the share of sustainable income is increasing. The debate about higher interest rates may perhaps be short-lived as there are increasing recession fears. In this kind of scenario, we usually observe turbulences in the capital markets and declining interest rates. I don't say that there will be a recession, but we need to be prepared. The impact on the various classes of business are quite different. And some of the main drivers of volatility and profitability in our business are certainly completely independent of the economic environment, like the frequency of nat cat events. In liability, the impact is different across lines of business. In motor and general liability, the by far biggest share of our liability book, positives and negatives will probably balance out somehow.

In property business, we would also expect positive and negative effects to balance out to some extent. Positive effect will be reduced loss frequency due to a slowdown of operations. And on the other hand, reduced investments in maintenance may increase loss frequency. In a recessionary scenario, more impact is expected to come from capital markets. At least we can say, we have a high rated fixed income portfolio with comparatively low exposure to credit risks.

On slide 11, the next topic, which is frequently discussed in the markets is climate change and related nat cat volatility. Due to our state-of-the-art risk and pricing models, which are updated regularly, we feel comfortable to understand and manage nat cat risks. Managing nat cat risks well, among other things, means to strictly limit exposures to frequency and aggregate covers, which make up only a small share in our portfolio. Alignment of interest is important as well. We want our clients to have skin in the game and not to simply pass on all exposure to reinsurers. Discipline is decisive for profitability.

Nat cat is historically one of our most profitable lines of business, which delivered average combined ratios of 70% to 75%, if we, for example, considered the last 10-years concretely. Knock on wood, this year has been quite promising as well, but we need these margins as nat cat business is volatile.

Slide 12. The topic of climate change is, of course, also a core element of the E of ESG. But first of all, let me stress that ESG management is deeply embedded into our organization and our Ambition 2025. This is underlined by self-imposed voluntary commitments and memberships. Within our insurance business, we contribute both to the adaptation and to the mitigation of climate risks. So in Greentech, we already insured renewable energy projects for a total nominal output of over 50 gigawatts over the last 13-years, and our products particularly address performance, longevity and financing risk. But we also invest in global renewable energy projects and a focus on certified real estate and forestry investments.

In sum, we are making good progress to reduce our carbon footprint and totally in line with our climate ambition 2025. And sure, promoting diversity and inclusion in all its aspects is a strategic ESG focus as well. Just to give a few insights, we increased the share of women in management from 35% to 38%, and we now count 114 different nationalities in our Group. And to add, we are quite proud that MSCI has just upgraded our ESG rating to AAA, stating Munich Re is leading peers in governance, responsible investing and in addressing emerging health trends.

Slide 13, brings me to the financial outlook, 2022, which is unchanged, compared to our quarter one communication with one exception. Given the low investment result in the first half, we lowered our guidance for the return on investment from above 2.5% to above 2%. However, due to our strong underlying earnings power, we were able to compensate a lower investment income, at least to some extent and are still aiming for a net income of EUR3.3 billion.

I would like to conclude with Slide 14 with the medium-term outlook, when we set our five year Ambition 2025. And we did that in 2020. We did not expect the pricing cycle in P&C reinsurance to persist for so long as we do see it now. At this point in time, inflation and interest rates were at much lower levels and no war was ongoing in Europe. So as you can see, a lot has changed since then. In total, these factors have so far provided more tail than headwind towards achieving our targets of the Ambition 2025 and have reinforced our capital management commitments.

With that, Christoph, I would like to hand over to you to give us the details of the first half year. Thank you.

Christoph Jurecka

Thank you, Joachim, and well, good afternoon also from my side. As always, I will not go through my slides, but I just would like to provide you with some more color on our Q2 results.

I'm quite pleased that we have achieved a resilient net result of almost EUR770 million and a return on equity of 12.3% given the challenging macroeconomic circumstances. I guess the story of the quarter is straightforward. Our strong technical performance in all fields of insurance business offsets a lower investment result as we had to cope with substantial fluctuations in the capital markets. At the same time, accounting noise left its mark on the net income that would look much stronger in economic terms, as our result was hit by accounting mismatches that I will talk about a little bit later.

As Joachim mentioned, the results achieved after six months keep us on track towards our full-year financial targets. In Q2, we achieved an investment return of 1.6%. The ROI in reinsurance, which has a more imminent impact on shareholders was even negative at minus 0.5%, where the ROI of ERGO held up relatively well.

Due to the downturn in global equity markets, we had write-downs on some of our equity investments, which were largely offset by equity derivatives and disposal gains on equities. In addition, sharply rising yields were detrimental for derivatives we used to manage duration and interest rate risks, reducing the group return on investment by around 1 percentage point. However, this P&L impact is purely accounting driven, reflecting the accounting mismatch between assets and liabilities as IFRS 4 is to a large extent, ignorant to changing interest rates. Economically, our interest rate position is well hedged.

Had we invested in fixed income securities instead of derivatives, which is economically exactly the same, the economic hedge would have also been an IFRS hedge. And the downturn would have equally not shown up in the P&L like the interest rate impact on the liabilities.

Finally, when assessing the investment result to currency result of almost EUR500 million should also be taken into account. As you know, currency for us is an asset class, which we actively manage albeit FX is not part of the IFRS investment result. Hence, all in all, I deem the investment return, including FX, to be quite robust. In fact, I'm glad that we can reinvest at much higher yields now, which will provide some tailwind for the running yield going forward.

In Q2, the reinvestment yield noticeably increased to 2.8%, which is clearly above the fixed income running yield. In tandem with the spiking interest rates, we lost most, but not all of our unrealized gains as positive off balance still offset negative on-balance sheet reserves. In that context, I would like to emphasize that this again is the result of asymmetric accounting under IFRS 4. Market value losses are immediately accounted for in the investment portfolio, while the value of largely undiscounted insurance liabilities hardly changed. This led to a reduction of IFRS equity, which pushed the debt leverage.

Economically. And this is what you can see in our solvency II ratio of 252%. Rising interest rates are clearly and only positive for our business. So I'm really looking forward to the introduction of IFRS 17 next year as a market consistent valuation on both sides of the balance sheet provides a much better picture of the economic reality. By the way, as you have certainly noticed, our interim report contains quite a lot of information about IFRS 17. To safeguard a high level of consistency, we will set our assumptions under IFRS 17 as close as possible to solvency II. In addition, our reserving approach in P&C business will not change.

Cautious reserving assumptions will newly also be accounted for in a lost component, which will unwind over time and be P&L neutral in a steady state on an annual basis. We'll offer more insights at our Investors Day on 15th of December, where we will also go into more detail as regards to valuation methods and the mechanism of CSM and risk adjustment.

As mentioned earlier, given the economic nature of both IFRS 17 and Solvency II. It should not come as a surprise that the sum of equity in CSM after tax will be in the order of magnitude quite close to Solvency II eligible owned funds despite some remaining methodological differences between IFRS 17 and solvency II.

Now let's turn back to Q2, starting with reinsurance. The Life & Health technical result, including fee income of EUR240 million came in well above the pro rata annual ambition. In line with our assumption that the largest share of COVID-19 claims would be accounted for in the first half of the year. COVID-19 losses amounted to EUR100 million in Q2. For the full-year, our evidence-based loss estimates still stands at around EUR300 million. Apart from COVID-19, claims experience was favorable in the U.S., Europe and in Asia, while rising interest rates additionally had a positive impact on claims reserves of around EUR65 million mostly in the United States and Australia.

Fee income was very strong once again and continued its pleasing growth path. After sound first half year results, we are well on track to achieve our annual guidance of a technical result of around EUR400 million, including fee income.

In Property Casualty Reinsurance, we posted a very good comment ratio of 89.7%, including major losses of only 7.5 percentage points despite the series of major natural catastrophes. This figure includes a runoff gains from prior year major losses, which is, of course, not unusual, given our prudent reserving policy also for large claims. With regards to losses in connection with the war in Ukraine, we booked additional reserves of slightly below EUR100 million in Q2. We are closely monitoring the evolving situation and potential additional losses that might emerge.

In any case, also because our remaining major loss budget for the rest of the year amounts to around EUR2.7 billion. We expect the ultimate claims burden to remain readily manageable for the group. The underlying performance of P&C reinsurance remains healthy with a normalized combined ratio of 94.9%. This number reflects an improved commission ratio, while the basic loss ratio is impacted by business mix effects, some larger losses below the outlier threshold and the inflation search taking into account the increasingly cautious loss cost assumptions in pricing.

Despite the ongoing strong profitable growth, reserve releases on basic losses remain at an unchanged high level of 4%. The healthy development in P&C reinsurance, however, is not properly reflected in the relatively low operating result of this segment. From my point of view, adding back the negative impact from interest rate derivatives and including the high FX result would provide a thorough representation of the business' earnings power or in other words, the operating result.

In primary insurance, ERGO continued its pleasing financial development, posting an increased net result of EUR160 million. In all segments, the underlying performance was healthy. German Life and Health business delivered a net result of EUR59 million, supported by a resilient investment result as equity impairments were more than compensated for by equity and fixed income disposal gains. In addition, the positive development of the technical result in Q2 was supported by some volatility in health over the year. This was mitigated by a normalization of claims development and travel. Moreover, the segment recorded a higher currency result, which, however, further burdened the operating result as policyholder participation is booked as a negative impact on the operating result.

In P&C Germany, we achieved strong premium growth above market estimate and a very good operating performance. The combined ratio of 86.9% in Q2 benefited from favorable claims development and continued premium growth, as well as a lower amount of major losses. The first half year comment ratio of just below 92% is well on track towards the full-year guidance. The ongoing positive development of international business with a combined ratio of 94.5% reflects the successful strengthening of our presence in core markets.

In Q2, we achieved further growth despite divestments in the prior year. The quarter was particularly strong in Belgium due to an exceptionally high result in health, in the Baltics and in Austria. With a combined ratio of 93.5% in the first half year and given seasonality effects, we are still underway to achieve the full-year guidance.

I would like to conclude with some remarks on capital management. The Group's economic position remains very strong. The Solvency II ratio increased to 252% in Q2 driven by good operating earnings and the sharp rise in risk-free interest rates. The ratio significantly exceeds analyst consensus of 238% as especially the increase of euro interest rates by around 100 basis points in Q2 after similar movements already in Q1, reduces the SCR significantly, in particular at German primary life entities.

The Q2 Solvency II ratio includes the redemption of two subordinated bonds in May and the issuance of a new green bond in the quarter. As these were similar in size, the net impact was marginal.

Now that's it from my side. Joachim and I, we are looking forward to answering your questions. But first, I'll hand it back to Christian.

Christian Becker-Hussong

Yes. Thank you, gentlemen. We are good to go for the Q&A. [Operator Instructions] So thanks for that and happy to get started.

Question-and-Answer Session

Operator

Ladies and gentlemen, at this time we will begin the question-and-answer session. [Operator Instructions] The first question is from Will Hardcastle from UBS. Please go ahead, sir.

Will Hardcastle

Hey, everyone. Thanks for taking the question. You mentioned now that the inflation risk is particularly challenging on the back book in P&C. I guess how much comfort can investors take on the actions that have been taken year-to-date in '22 as well as what we've taken previously.

I guess, rather than thinking about a potential for a big cliff edge impact on any Q3 reserve review? I guess linked in with that, is there any early trends arising from U.S. courts reopening?

And the second one is just a quick one, a quick clarification actually. On the off-balance sheet reserves, which you mentioned on Slide 51, there's loans that now carry about a negative EUR1 billion negative value. I guess that's down EUR9 billion year-to-date. I'm just judging what exactly are these? Thanks.

Christoph Jurecka

Yes. Well, good afternoon. Let's start with the second one, loans, I think that's a quick one. loans are basically mortgage loans or other non-listed fixed income type of investments we're holding, especially in our primary life entities and they account -- there -- the reserves accounted for as off-balance sheet reserves.

Your first question on inflation, how much comfort you can have with the measures we took? I think I can only reemphasize what we discussed a number of times already. Our reserve position is a very strong one. You know that on top of the actual reserves we have putting aside for certain -- for our business overall. We have a bulk general reserve, which we also strengthened at the last time end of last year, particularly for some inflationary threats without having seen any specific need at that point in time.

So the reserve position overall is very sound. We have reacted immediately in pricing. So wherever inflationary trends became obvious in pricing, we reacted immediately in a conservative way. You can see that if you look back into the renewal numbers we have been releasing earlier this year or also today, we're always talking about rate changes, including all the inflation assumptions being fully offset already or taken out of these pricing numbers.

And then the margins continue to be at least stable in the first half of the year. So I think that was also decisive actions we have been taking. On the asset side, we have quite a number of assets which are inflation sensitive, which should additionally offset inflationary effects going forward.

And so I think we are as good prepared as you can be. And now we are quite carefully observing the situation. And as you mentioned, in Q4, as usual, our reserve review will take place as every single year, nothing specific or nothing spectacular.

With that on your question on social inflation catch-up effects, that's a very specific question. Also there, our reserves are very, very sound, very, very conservative in a sense. But when it comes to court activity, there are some statistics, and you probably have seen them as well that the court activity has increased now again. So I wouldn't rule out catch-up effects for the whole industry there. But we are observing that completely relaxed given the strength of our reserves. I'm not sure if that answers your question, but that's pretty much how we see from a reserving perspective at this point in time.

William Hardcastle

That's really helpful. Just one really quick follow-up. You mentioned the assets that will benefit from inflation, sensitive assets. Can you just maybe touch on those and whether any of that has already been benefiting through the P&L? Or are these sort of not mark-to-market through the P&L? Thank you.

Christoph Jurecka

Yes. Thank you. I mean the question you're asking is indeed a difficult one because timing differences are just huge. And from an economic performance already last year, we saw some positive performance of some of our inflation-linked nodes to give you one example, not immediately hitting the P&L, but positively contributing to economic earnings, that was last year.

In the first half of the year, we realized some of them are of the realized gains, you particularly see on the fixed income side. If you look into our deck, a part of that is inflationary notes where we thought it would make sense to realize some of it without leaving our position unprotected. So wherever we realize some of that, we replace them by similarly sensitive assets, for example, inflation swaps or similar kinds of assets. So the overall protection level should be pretty similar.

So yes, some of that did -- some of that entered into the P&L already, others didn't. And so there's also potential going forward. I think that's the answer generally.

William Hardcastle

Thanks very much.

Operator

The next question is from Andrew Ritchie from Autonomous. Please go ahead sir.

Andrew Ritchie

Hi, there, I just wanted to follow-up on comments Joachim made about what you've done on renewal pricing and loss cost assumption. First of all, I'm assuming nominal pricing in July renewals was higher than nominal pricing earlier in January. But the loss cost has sort of moved up as well. So you ended up with a plus 0.1% versus a plus 0.7%. Can you give us some of the moving parts there, if any, directionally, if not the absolute level of nominal loss cost? And so linked to that, can we still expect in time, the normalized combined ratio to trend down because of the unwind of some of the conservatism and loss cost or because there's mix effects going on as well because you're growing more in short-tail business?

My second question is on European motor, motor reinsurance business. Can you just give us some assurance on the protection you have from sliding scale commission given the severity and the inflation impacts we're seeing in motor specifically or your clients are seeing? And to what degree you derive comfort from those sliding scales or whether there's a risk of underlying exceeding on the protection there? Thanks.

Christoph Jurecka

Andrew, yes, Christoph, here. I think I'll take all of your questions. Your two questions have been quite a lot. So if I forget something, please follow up on them. I start with the renewal 1/1. And I think your assumption is fair to say that the inflation peaked more now on towards half year than what it did at the beginning of the year. So if we would have exactly the same treaty to be renewed half a year ago or now the normal increase would indeed be high -- have been higher this time than six months ago, which is only logical given that the inflation also carried on until now.

Now in reality, you have different treaties, you have different geographies and different lines of business you're looking at. But yes, the general view on that is exactly like you described it. On the normalized combined ratio, you know that the target is 94% for that year. And you're also aware of the fact that we increased the large loss loading from 12% to 13%. Which in itself for an unchanged comment ratio makes the normalized comment ratio even more ambitious than it would have been normally. I think that's something which we noted already at the beginning of the year that this normalized common ratio target for this year is particularly ambitious, just given the increase in the large loss budget.

And the way we look at that, we always first budget for the overall combined ratio. And then as they are off position, the large losses. And then if you take the overall minus large losses normalize this resulting on more or less, it shows you that all these various items, they're not completely independent of each other.

Having said that, if you look at Q2 at our results in Q1 also, the 94.9%, they show a trend going towards lower numbers if you compare it with where we have been last year. And now there are certain -- and I mentioned that in my presentation, I think certain items which you have to take into consideration when looking at that number. Those are, for example, larger losses below the outlier threshold, but still large enough to be noticeable. We have some business mix effects, which have to be taken into consideration. So 94% is not equally good, if you look at one or the other type of our business. So the business mix plays a role here. And so if you write less of the, for example, primary insurance business or the reinsurance in certain lines, it will have an impact on the normalized comment ratio, because some of those businesses have just expected combined ratios deviating quite significantly from the 94% target. So business mix effects also played a role in Q2.

And then we have this item on inflation where in pricing, we have been conservative. I told you that. And then there are certain business where the initial loss picks are quite similar to the pricing assumptions. So in a sense, you have a kind of automatic reaction to that. And then again, we will look deeper into that only in Q4 when we do the full reserve analysis and reserve review. Therefore, I think for now, I can only confirm that the target is 94%. Given the inflationary environment, obviously, there is a driver, which is more pronounced now maybe than six months ago that make it particularly easier.

On the other hand, I have no reason at all to believe that the 94% is not achievable at this point in time, just given the developments we have been seeing. And so we are waiting and seeing for the development until the end of the year to then be in a position to finally judge what the outcome will be. Sliding scale. Indeed, there are -- I mean, sliding scale. This is one example for treaty design, which helps us to cope with the impact from inflation. But there are others as well. They are in certain markets. You have certain clauses, which help you offset inflation effects also in nonproportional 3D structures. So there are certain elements in underwriting which help you as a reinsurer to detach yourself a little bit from inflation.

On the other hand, there as well, that does work to some extent, but for sure, not indefinitely. So therefore, it's a helpful element and plays a role in the analysis, but it goes only as far as it goes. And now I hope that I've covered everything you've been asking. Otherwise, please follow-up.

Andrew Ritchie

No. That’s great. Thank you. Thanks.

Operator

The next question is from Freya Kong from Bank of America Security U.K. Please go ahead.

Freya Kong

Hi, good afternoon. Thanks for taking my questions. Firstly, could you give us some indication of the quantum of positive development within the nat cat losses in Q2 and which years or events are you seeing positive development on? And secondly, just on Life & Health Re, the fee income was quite strong in Q2, up almost 50% year-on-year. Were there any one-offs within this? Thanks.

Christoph Jurecka

Sorry could you repeat the second one, please? I didn't really hear that.

Freya Kong

The fee income in Life and Health Re was very strong. Was there any one-offs within this or just a good trajectory? Thanks.

Christoph Jurecka

Yes. The second one is just a very good trajectory. So no one-offs. And the prior year on large losses, there, we deliberately said we are not going to release a number and I can give you the reason for that. We are usually very happy to quantify everything, which is a one-off kind of character. But these prior year developments, they are not one-off-ish. They are really part of the usual general development, how we do the reserving and how also these large losses, then over time, are getting more and more concrete. And once they get more concrete generally, we end up having releases also on them, similar like in the basic loss area. And as this is just a usual pattern and nothing specific, I'd rather not mention a number here.

Freya Kong

Okay, thank you.

Operator

The next question is from Kamran Hossain from JPMorgan. Please go ahead.

Kamran Hossain

Hi, good afternoon. I've got two fairly big picture questions. So the first one, I guess, when you're talking about the Ambition 2025 target, it sounds like you're incrementally more positive on, I guess, the tailwinds. Now if I go back to the December 2020 slides and I look at the waterfall chart that you gave on going from the normalized 2020 return on equity to the 2025, 12% to 14%. I look at the moving parts in theory, they've all improved. So in terms of kind of what's going on there, at what point do you think it will be time to update that guidance for the 2025 return on equity? So that's question one.

The second question is coming back to the comments around the market, where again you sound very positive, particularly for January, which makes sense given everything that's gone on in the world. However, given kind of the risk backdrop, margin expansion looks pretty weak. 0.1% is understandably conservative, but still, it doesn't seem that's exciting, particularly compared to other kind of recent periods in the market. So why are you still very positive on the market? And why do you think things are improving if maybe the numbers that you're suggesting don't really kind of give that much support? Thanks.

Joachim Wenning

Thanks, Kamran. This is Joachim. Thanks for your questions. Let me start with the second one. You're right in stating that 0.1% looks like pretty marginal. It's close to zero, it looks flattish. That's right. So why are we positive?

First of all, we were positive already at the level of the rates last year before we went into the renewals. And then given that there is a loss development and increasing loss development and that there is inflation, which further drives losses upwards seeing that the market fully compensates for those increased inflation assumption, but fully and fully our conservative assumptions, that's very good news because if you think about it, it could also have been realistic almost that you say the market will try to catch up with inflation, but does that in one or two or three steps. This has happened in one big step, this we consider a positive.

And with regard to your first question, Ambition 2025, is it already time to reconsider or review our ROE ambition of 12% to 14% for 2025. I have to say. First of all, we are in 2022, and there is still time to go into 2025. So already timing-wise, it will be too early to reconsider this either up or either down.

And secondly, we told already back in 2020 that the key driver towards 14% ROE would be our capital management, would be dividend payments and would be share buybacks. So with no dividend increases and share buybacks, it will be difficult to even reach 14%. So I would just comment it at this point, like the following: growth and rate development in P&C reinsurance have given us tailwind that we move more comfortably in that range, but we don't review it.

Operator

The next question is from Ivan Bokhmat from Barclays. Please go ahead.

Ivan Bokhmat

Hi, thank you very much. I've got two questions. The first one on the investment portfolio. So far, we've touched upon the benefits of your risk assets to offset inflation. But I'm just wondering whether you feel the need to prepare it for a downturn on the credit risk or looking at your EUR10 billion unrealized gains sitting on the balance sheet, I suppose, any reallocation might be quite costly So what comfort can you give us that any changes you might need to do to the portfolio are not going to cost much in terms of the P&L?

And the second one, it's actually on solvency. I'm just wondering that given the move we saw on the interest rates have been so beneficial. How do the sensitivities look now? And has there been also a change to the sensitivity to credit spreads? Thank you.

Christoph Jurecka

Yes. Well, Ivan, thank you for the question. With the investment portfolio, I think we are in a very resilient position. So there is no pressure, no urgency to rebalance it. Neither short notice, no, not in the meantime. I mean, the strategy clearly is to be able to stick to a strategy over the cycle and if you look at our capitalization numbers, they even go up in the current environment. So I may be only one -- once again, I promise for the last time today, I will mention the topic of the accounting mismatch because finally, economically, even in these difficult times from a capital market perspective, our own funds have been increasing. We are making money there, right?

Only just in IFRS, it doesn't show up like that. And I have to add in IFRS 4 because next year, when we're going to look back into the actual year, nobody will speak about IFRS 4 anymore. It will be IFRS 17 and that the interest rate dynamic is also a completely different one, right?

So just as a quick reminder, we feel very comfortable. We have a stable positioning, and there's no need to rebalance at all. The credit position, I think Joachim mentioned that earlier, that we deem it is a very conservative one also in a peer comparison. And the interest rate risk anyway is managed the situation get close to zero, so interest rate risks are minimal. And our equity holdings overall, they are pretty small as well. And in any case, potential losses on this portfolio is digestible. And we have certain protection levels from derivatives we are holding.

Solvency, so the question you ask is a very valid one because the sensitivities as we published them half a year ago were no good indicator for the development as we saw it until Q2. And the reason is very clear, these sensitivities are linear approximation around interest rates where we currently are. And particularly our life primary books have a very non-linear behavior as soon as more significant interest rate movements, more significant interest movements are happening. And now we nearly -- we saw nearly 200 basis points of development in the interest rate, an exceptionally big shift.

And the sensitivities, it's impossible that you really meet the right number based on these sensitivities. As we are now at much higher interest rate levels as at the beginning of the year and even after the first few weeks in Q3, where the interest rates came down a little bit again, still we are far away from where we were at the beginning of the year. So I would still say that the sensitivities are not giving great guidance at this point in time. The general direction is that with higher interest rates, we over-proportionately benefited the life primary businesses due to this non-linear effect. So in other words, the safety purpose we're having in those companies they go over proportionately with interest rate.

And part of the reason for that is really also the very risk, very cautious and conservative risk modeling we are having in place. We have been talking about that a lot when interest rates were lower and lower every single quarter. And now what's happening is more or less the reversal of that. And therefore, we are over-proportionately benefiting now in the context of a very cautious modeling approach.

Operator

The next question is from Iain Pearce from Credit Suisse. Please go ahead.

Iain Pearce

Hi, thanks for taking my questions. Just two on the investment side. In terms of the investment portfolio, just looking at the allocations of Slide 44, it shows the over 10% of the portfolio is either in subprime credit or is the fixed income portfolio subprime credit or nonrated credit. So if you could just give us some comfort as to what sits within the non-rated bucket in fixed income, why we shouldn't be worried about that? And similarly, why you're comfortable with the subprime holdings that you have, especially if we think about heading into a potentially recession scenario?

And then the second one is just on the equities. Given the sort of write-downs that we've seen on the equity holdings, if there is a further downturn in markets, will we have to see further impairments? Or is there some headroom versus the impaired level? And similarly, if we were to see a more positive move on equities, would that still go through the OCI? Or would there be any P&L impacts? Thank you.

Christoph Jurecka

Yes, Pearce. Thank you. So generally, our investment strategy is a strategy where our fixed income portfolio very much is based on the highest credit classes. So as you can see on that slide, it's 42% AAA and then 23% AA. And then just in very selective cases, we had lower credit quality to that to increase the earnings expectation of the portfolio here and there. And then what is also happening sometimes even if you pick the most conservative credit initially, and you have some fallen angels, as we call them, whether the credit is just downgraded.

And then sometimes we just hold the position and we're not for sellers when we have a positive credit outlook and then think that the title will recover, and we will be able to get it back at 100. So that's one of the reasons. Non-weighted, we have -- I mentioned that before already, we have also some mortgages. So some asset classes, which are intrinsically non-rated. So for retail clients, for example, some policy loans also these kind of things are fixed income instruments, obviously, there is no waiting.

So generally, I think I would leave it with that answer. And maybe just only underline again that the overall portfolio composition is a very conservative one. On the equity side, yes, I think the question was if we are able to hold the equity positions? And then if we are, we would -- also with a positive view on the market, you can be able to build up more equity at this point in time, we are happy with what we have. We have some protection in place in the portfolios where we would -- yes, where the risk capacity is may be a little bit limited or where we would have to share the losses in a different way with policyholders than potential gains so that there we have derivative protections in place to be -- then again, able to maintain equity positions for a long time.

And therefore, we can sit and wait and look at the development as this is going, which does not mean that selectively, we also have been selling stock. And sometimes we do so to realize some gains to be very open and sometimes we do it for portfolio management purposes, both is happening.

And from a -- I think the last part of the question was on an accounting perspective, it's -- I mean if we -- it's once impaired, always impaired. So once we impair them, it's basically that the impaired status is maintained. And then is the basis then for the ongoing accounting in the upcoming quarters.

Operator

The next question is from Vinit Malhotra from Mediobanca. Please go ahead.

Vinit Malhotra

Yes. Thank you, Joachim. Thank you, Christoph. Just -- so many of the market questions have been answered. So I'll just look at two more topics. One is Ukraine is where just when we read the press release, the outlook section -- and I'm just reading now it says that there continues to be considerable uncertainty regarding the financial impact of the Russian war. So I'm just curious that this statement is meant to be a generic kind of uncertainty persist statement? Or do you foresee any particular risks, aviation could have been one, but do you foresee any risk to your about EUR 200 million estimate on Ukraine? So that's my first question.

Second question is, if I can just look at Slide 51, and this is more on the topic of the whole balance sheet and interest rates and the gains underline still left or supposed to be left. But the loan area in the off-balance sheet, that's quite eye-catching in a sense that it is still hanging on to positive territory EUR3.7 billion even in 1Q, and it's certainly really gone down to a minus EUR1.1 billion. So could you just get us a bit about what loans are these?

I mean, I can see that there's a slide which shows that some of these are loans or classified as loans, but they are also to government and fund fees for covered bonds. Could just discuss a bit, if possible, about this aspect of the underlying gains movement because obviously, this is still positive in 1Q and could have been helpful, but now it's also gone negative? Thank you.

Christoph Jurecka

Thank you, Vinit. I start with the loans. And I think we had it before already. So part of that are mortgage loans, others are private placements, so fixed income titles, which are not listed or not traded regularly at stock exchanges. As common in the German primary insurance space. So most of them are being held by our primary insurance carriers, particularly in Life and Health. And the situation of them is relatively long. This is also why interest rate movements have a bigger impact on them. Once interest rates go down, and therefore, you have a relatively big shift in the reserve position. Here, I think the good news is that the accounting treatment for the loans will change in IFRS 9 next year. So this particularity is one we will not have to discuss a lot anymore in the future.

The second question, Ukraine, the EUR200 million, we have been booking this quarter or this half year is the best estimate. So coming back to your question on the outlook, if there was anything we would know or assume already we would incorporate in the best estimate, we would have incorporated in the best estimate. So the clear answer is, no. It's just a general statement. It's not something concrete. And if there were something concrete, it would have been built into the provisions already.

Vinit Malhotra

Okay. Thank you, Christoph.

Operator

The next question comes from Darius Satkauskas from KBW. Please go ahead.

Darius Satkauskas

Hi, thank you for taking my questions. In your July renewal slide, I noticed that you used a slightly different language in talking about rate increases. Instead of talking about risk adjusted, you now mentioned risk and inflation adjusted. Has there been any change in how you measure that rate? Or are you just trying to emphasize that you're being compensated for inflation? That's my first question.

Second question, given reinvestment yield has gone up materially, do you see any signs of pushback from your clients when you ask for higher premium rates? Is this something that you would expect in the near-term? Thank you.

Christoph Jurecka

Yes. Thank you, Darius, for the question. The first question, no, the methodology is completely unchanged for many, many years already, and this is something which is highly important for us as well to have the comparability of numbers. By the way, not between -- not only between the various quarters, but also the methodology, of course, needs to be in line with the way we measure the combined ratio such that we have the possibility to find the price changes later on also once earned through in our combination numbers. And I think we already in the past showed a high level of consistency here in the methodology, which I think is very important. So nothing changed there.

The second question, the higher reinvestment, no pushback from clients. We are in a hard market phase. It's rather the opposite. We had a very late renewal in some markets. And so price -- we had a lot of support for price increases in the market, high demand. So currently, the higher interest does not have any impact at all.

Operator

The next question is from Ashik Musaddi from Morgan Stanley. Please go ahead.

Ashik Musaddi

Yes, thank you and good afternoon, Joachim. Good afternoon, Christoph. Just a couple of questions I have is, first of all, I mean, on the call, you mentioned a couple of times that higher interest rate is disproportionately helping the Life German book. Is it possible to quantify that? I mean, in terms of capital, or are we going to get more cash flows, more earnings from that now? Just because things have improved. I mean what are the real benefits? I mean, clearly, we understand that higher rates means lower duration -- higher rates means lower reinvestment risk, et cetera. But does that translate into anything improvement in terms of cash, capital earnings, et cetera, or a one-off capital release, something like that? So it would be good to get some color on that? So that's one.

Secondly is -- I mean, you reiterated the guidance of EUR3.3 billion versus if I'm not wrong, you did EUR1.4 billion for first half, I mean, still EUR1.9 billion to be covered. What would be the driver of that EUR1.9 billion for second half? I mean would you say there is any sort of capital gains baked into that? Or would you just say that it's more underwriting rather than capital gains or higher investment income? So any color on like some, say, bridge from EUR1.4 billion to EUR1.9 billion for second half would be very helpful.

And just one small question on inflation and pricing. I mean when you say net of this 0.1% rate improvement net of inflation. Would you say it's net of progressive inflation? Or would you say it's net of the inflation we are talking about right now?

Christoph Jurecka

Okay. I'll start with the last one. The way it works is that on the particular business we are renewing, the underwriters based on the CPI estimate. But only based on the estimate, they think about how concretely the inflation would be in the future for the business and for the particular book that you're looking at. And they're looking at driver like wages, like construction costs, like if applicable energy cost, if applicable social inflation. So a number of drivers and all of them behave differently, and they clearly bake in the expectation going forward, which obviously still is an assumption. So those assumptions will have to be revisited in looking at the real development going forward. But clearly, when we do the pricing, it's a forward-looking view.

The driver for the second half of the year, I think a straight forward, we are -- I mean, our run rate operationally is a very good one. We had a strong technical performance in the first half of the year, so that the clear expectation is that it's going to continue. On the investment result, there are a number of things which have more kind of a one-off-ish character where we do not expect them to repeat. So in very short, we expect a good technical performance to continue and the investment result to be closer to normal in the second half of the year. And then again, as a very quick reminder, the EUR2.7 billion large loss budget, we still have for the remainder of the year is a comparatively big number even in the context of our relatively large book.

And the first question, upside for life primary with rising interest rates. So yes, I mentioned it a couple of times, there is upside from that overproportionally. There's a time lag. You see it first in the Solvency II numbers, which you react immediately. In all other metrics, it takes some time until the development will be earned through. The duration of the bonds, for example, in the life business is a relatively long one. So it takes some time until the higher yield is really earned in those books and until it leads to higher cash income also in these entities.

So it's nothing with immediate effect. But long-term, obviously, there's only one correct answer to your question. Yes, very obviously, the life companies will benefit from that. We'll have higher margins, higher earnings. And then eventually, that there's a potential then also for higher dividends from the life companies. This has to be seen in the context of ERGO overall. You know we manage ERGO altogether. And ERGO has been paying high dividends anyway already over the last couple of years. And also within ERGO, there is a balancing item. So in one year, it's potentially the P&C company, which is contributing more to the ERGO dividend, in other years, it's more the life company.

So therefore, there's of an offsetting effect also, which you have to keep in mind. It's not like adding up just simple companies, but ERGO as a group, which also has to look at their financing from a subgroup perspective. But in an isolated view on life, I can only confirm what you just said.

Ashik Musaddi

Okay, great.

Operator

The next question comes from Derald Goh from RBC. Please go ahead.

Derald Goh

Hi, good afternoon, everyone. Two short questions, please. The first one is just on Risk Solutions. Could you maybe comment on the growth and combined ratio performance for the first half, please?

And my second question is just back to the July renewals. If I look at the bubble chart on slide eight, it looks like you've grown quite strongly in property cat. Is there any more color you can add maybe things like apparel or the region or client types? Thank you.

Christoph Jurecka

Yes, I'll start with the Risk Solutions question. As you know, we are not releasing combined ratio numbers for subsegments during the year. So therefore, I can only mention that I think the profitability is fair to say that it develops absolutely in line with our expectation. But more precise number is something we can only give at the end of the year.

Growth wise, we see substantial growth more or less across all the units there. And I don't think there's any specific entity I'd like to highlight particularly here. But growth-wise, and I think Joachim also mentioned that in his introduction, we are very happy also with the development of the Risk Solutions business.

Joachim Wenning

With regard to the other question, the July renewals, you're referring to the property XL renewal. And where they're coming from, right? They are pretty much coming worldwide. A big chunk North America, but also from Far East and Latin America. So pretty much widespread.

Operator

The next question is from Thomas Fossard from HSBC. Please go ahead.

Thomas Fossard

Yes, good afternoon, gentlmen. Two questions on my side. The first one would be on your year-to-date experience regarding large losses, both in nat cat and man-made. Can I ask for a qualitative comment on your side? I mean, how you assess your absolute and relative performance compared to peers, compared to the industry?

It seems to me that you're running significantly below. I mean, clearly, your normalized large loss budget, but significantly below peers. So are you thinking that or seeing that you're doing something different or that you've been lucky? Or could you just share your view on your year-to-date performance on this side of the business?

The second question would be related to your previous comments regarding the pricing dynamic in the industry. And I think, Joachim, you indicated that this was a matching inflation -- loss inflation trends, which is good. But meaning that would you say that next year, if inflation is starting to increase in terms of momentum? I mean, would you expect pricing -- nominal pricing to react accordingly to these? Or do you think that next year, potentially, you could be in a situation where you could have a bit of margin expansion, i.e., keeping nominal prices running at elevated level and inflation, loss inflation trends starting to level off? Thank you.

Joachim Wenning

Thank you very much, Thomas. I take both questions. So with regard to our large losses or the large loss portfolio of ours. I mean, I'm happy to comment on it. It's performing very nicely, if you like, into the actual so performing a combined ratio of 19.5% by half year is just outstanding, I would say, we should enjoy that. And we particularly enjoy that to also show after so many years of not benign losses that in good years, that makes quite a difference. And yes, you're right. If we just compare the numbers of some of the peers that they have reported, I don't know their portfolio. I don't know what they have written. I really don't know, but it looks like that our numbers are this time pretty much better.

But we cannot comment on why that is the case and to what extent we have done anything different. I can only say we have done a lot right. With regard to pricing dynamics, for next year, I mean, I would wish to give you a concrete answer. It's so difficult. It's almost impossible because you're saying will margins increase maybe next year because nominal increases may be what they are now, but the inflation increase will be less than this year. Frankly, we don't know.

What I can tell you though is that with regard to peak risks, particularly in this nat cat framework. There is a shortage of capacity. So with regard to peak risks, I would not exclude that there is a further margin increase. Going forward, with regard to the nat cat business very broadly, it will also depend on the full year 2020 large loss experience, I think. Thank you.

Operator

The next question is from Dom O'Mahony from BNP. Please go ahead, sir.

Dominic O'Mahony

Hello, folks. Thanks for taking the questions. The first question, just on slide eight. I was a bit surprised, I think, to see the property proportional portfolios seeing what looks like a negative price change given the narrative around property pricing more broadly. I might have thought that it might be nudging up. Clearly, the property XL, I think is very good. But I was wondering if you could explain maybe whether there are particular segments or geographies driving the weakness in property proportional?

Second question, I just want to clarify my understanding of the FX results. I think the way you've described it to us is we should sort of maybe think of the FX result as part of the investment return. And it's an accident that it's just below the operating line. Is that because your team are essentially taking directional positions on currency, they're good at it? And so we should see it as part of that overall performance. Or was it actually that the FX result is just the expression of the hedging of the portfolio? And so actually, to be tied up in the overall portfolio return? If you could just clarify what that's about? That would be very helpful. Thank you.

Christoph Jurecka

I'll start with the FX question. And on FX, it's basically a combination of what you're saying that the starting point is always a replication of the liability structures as we have in the various currencies. But on that basis, then we actively take positions. And it's a deliberate decision of our portfolio construction team. If they would like to take bets or positions on the equity side or on the FX side or on the interest rate side or on credit. So in that sense, then with the starting point being the liability structure, FX is just -- it behaves and feels like any other asset class.

And what we did I think, very successfully over the last at least six months is that we had U.S. dollar long positions, deliberately and going beyond what we would have needed to hedge our liabilities. And we were benefiting significantly from that U.S. dollar long positioning both in the IFRS world, just below the line, but also in economic terms, so in Solvency II or in our internal economic dealing framework, and this was really taking a position.

Joachim Wenning

Dom, I take the other question with regard to the property proportional book. So you're right, rate-wise, after applying conservative inflation assumptions as with all other lines of business as well. We have seen this slightly negative in its price evolution. And that's why we have reduced our exposures. Where does it apply geography wise? It applies broadly, but so far, particularly in the U.S.

Dominic O'Mahony

Very helpful. Thank you.

Operator

The next question is from James Shuck from Citi. Please go ahead, sir.

James Shuck

Good afternoon. Two questions from me. Firstly, just interested in the P&C regrowth of 19% at H1, in particular, how capital consumptive, that is? Are you able to give an indication about how the SCR is evolving for underwriting risk in P&C Re? And is there any kind of rule of thumb to think about how that's diversifying way and for projecting out how the SCR responds to that top line growth?

The second question is really around your P&Ls. So if I look at how your largest peak payrolls have developed over the last few years, that's now grown to about 25% of the tangible net asset value, and that was at 2021. Obviously, you're growing in that cap now. You've got that top line growth coming through and the comments you've made are supportive of growing more in the kind of property XL kind of area. So where do you feel that number is going to go to in 2022? And what's the kind of natural limit for your exposure to the large peak payrolls in relation to that P&L, please?

Christoph Jurecka

Yes. Good afternoon, James. I'll take both of your questions. The first one, I mean, the SCR development is not something we are regularly showing in the quarters. But as a rule of thumb that I could give you is that, I would say, largely proportional. So the diversification is largely similar to what we saw at year-end. And as the book is broadly diversified already, adding additional business here and there does not change the overall picture. So -- or in other words, the SCR intensity as presented in our analyst conference, I think it was in February, is largely unchanged.

Now what is the limit? Or is there any natural limit? Well, the question is what is natural? I mean, there are clear risk limits in place. And in the context of our risk strategy, where we are very actively discussing and then taking decisions on how far we go for each of the major payrolls individually. These risk budgets they are hard limits for the underwriters. So in that regard, there is not at all the possibility for unlimited growth. But the limits that they have are of high importance to us. The way they are constructed is that they are based on our internal economic viewing, the limits that they are a function of available capital as we have said.

And what is very important in that context is that the limits also include a few that the overall portfolio continues to stay balanced. So we have and we do make sure that the diversification between the various pair wheels is not disturbed by over-proportionately just going only one of them. And that's how it works mechanically. These risk limits, as I mentioned before, a part of the risk strategy being approved by the Board of Management and being discussed even with the Supervisory Board, so they have a very high relevance and the high importance for us. And then we do stick to them.

Operator

The next question is from Vikram Gandhi from Societe Generale. Please go ahead.

Vikram Gandhi

Hello. Good afternoon, everybody. Can I just ask a question related to where we are with the COVID reserves, both on P&C and Life & Health, maybe what the IBNR position are at the end of first half? And how do you particularly view the -- some of the lines developing, let's say, BI versus [indiscernible] over the next couple of quarters? That would be really helpful. Thank you.

Christoph Jurecka

Yes. Vikram, thank you for the question. Not a lot of news to be reported to be honest, on these reserves. We will -- we visit them at our year-end results review later this year. And in between, we just decided to keep them constant. So even in lines where there's an even lower activity than in other lines, even there, we would not touch the reserves just right now as we will only do that at the year-end. On average, the IBNR is roughly 50% still.

Vikram Gandhi

Okay. That’s very helpful. Thank you.

Operator

Ladies and gentlemen, due to the time of interest, we will now have to stop the Q&A now. And I would like to turn back to Christian. Please go ahead.

Christian Becker-Hussong

Yes, thanks a lot to everyone for joining us this afternoon. Pleasure speaking to you as always, please, if you have further questions, don't hesitate to get in touch with us. Happy to help at any time and yes, I hope to see you all soon in person again, have a nice remaining day and a great summer, hopefully, great summer holidays, and looking forward to see you afterwards wherever. Thanks. Bye-bye.

Operator

Ladies and gentlemen, the conference has now concluded, and you may disconnect your telephone. Thank you for joining, and have a pleasant day. Goodbye.

For further details see:

Münchener Rückversicherungs-Gesellschaft Aktiengesellschaft in München (MURGY) CEO Joachim Wenning on Q2 2022 Results - Earnings Call Transcript