LONDON/FRANKFURT (Reuters) - Germany's Munich Re and British insurer Legal & General saw their shares fall yesterday as investors digested tough details from their financial results amid a financial market rebound.

Shares in L&G, Britain's fifth-biggest life insurer, fell nearly 13 percent at one stage after it said a one-off drop in investment returns knocked more than 90 percent off operating profit in the first half of the year.

The world's biggest insurer said its investment income rose almost 40 percent, helping it deliver second-quarter net profit comfortably ahead of analysts' expectations, though down 30 percent on the year.

However, Citigroup analyst James Quin said Munich Re's substantial realised gains masked weaker operating results.

"The company has put on healthy top-line growth, but on an organic basis the performance is weaker than for most European peers," said Quin, who has a "hold" rating on the share.

Munich Re shares fell nearly 2.8 percent before paring losses to close 2.2 percent lower, lagging a flat insurance sector. L&G ended the session down 4.8 percent.

Munich Re was more positive, saying it might return more cash to investors by resuming share buybacks later this year, while L&G indicated its balance sheet needed repair and cut its interim dividend 45 percent.

"There are cracks everywhere," said ING analyst Kevin Ryan.

European insurance stocks fell steeply in March on concerns falling equity prices and rising corporate bond defaults could eat into insurers' capital, potentially forcing rights issues.

The shares have since rebounded and the DJ Stoxx European insurance index is now up 2 percent from the start of the year.

L&G blamed its weaker performance on losses on bond sales as it tried to make its investment portfolio less risky, and on charges incurred after a currency hedging programme went wrong.

These formed the bulk of total "negative investment variances" of £359 million.

"The main problem is the company's been doing what people have been telling it to do, which is get out of assets the market doesn't like," said MF Global analyst Peter Eliot.

Munich Re said it would stick to a cautious investment approach, with finance chief Joerg Schneider saying the company did not expect to hold more than five percent of its investment portfolio in equities, despite the share price rally since March.

"Given the volatile capital market environment, we preferred to deploy our financial capacity to cover insurance and reinsurance risks rather than speculate on cyclically fragile stock market rallies," Schneider said.

He said achieving Munich Re's targeted return on capital implied it would deliver net profit of around 2.5 billion euros in 2009, and it had already made 1.1 billion euros toward that goal in the first half of the year.

Munich Re said it might resume share buybacks in the second half of the year, depending on market conditions, after suspending its repurchase programme in April due to the financial crisis.

Chief executive Nikolaus von Bomhard said it could repurchase a "maximum" of 1 billion euros by its annual shareholder meeting in 2010 if it did not find better opportunities to plough the cash into its underwriting business or make acquisitions.

L&G's dividend cut was expected by analysts, although most had forecast it would match the 50 percent reduction it made to the final shareholder payout of 2008.

The British insurer said the smaller cut reflected its growing confidence in its capital position and its ability to generate cash.

L&G's operating profit for the half year under international financial reporting standards (IFRS) was £31 million, down from £391 million last year and far below analysts' expectation of £248 million, according to the average of 13 estimates collected by the company.

Under the alternative European embedded value (EEV) standard, usually more closely-watched by the market, L&G's profit rose 12 percent to £657 million, surpassing analysts' expectation of £466 million.