Property Casualty Insurance 06 10
-
Upload
gerard-alba -
Category
Documents
-
view
187 -
download
0
description
Transcript of Property Casualty Insurance 06 10
1 / 66© 2010 SIA Group – www.s-i-a.ch
Property & Casualty Insurance
June 2010
Main message: the Property & Casualty Insurance sector offers very good investment opportunities at current prices. Moreover, it’s likely that those opportunities will be frequent.
1. Sector Analysis
AGENDA
2 / 66© 2010 SIA Group – www.s-i-a.ch
2. SIA Analytical methodologies
3. Some specific cases
4. Conclusions
5. Q&A
The P&C business is mature, but wide differences in penetration imply further growth
Market capitalization
Property & Casualty Insurance
Property & Casualty and Multi-line
Reinsurance Italy
Switzerland
Spain
Greece
Japan
China
India
Brazil
Russia
P&C premiums as a percentage of GDP
3 / 66© 2010 SIA Group – www.s-i-a.ch
(Total Market Cap: USD 50,000,000 mio approx.)
P&C insurance and Reinsurance add up to 2% of total market capitalization
Share of sub-industry in financials services industry has been stable over the last ten years
Banking
0% 5% 10% 15% 20%
US
UK
Germany
France
Italy
The industry has its own cycle, uncorrelated with the economy
• Demand (premium growth rates) in line with historical GDP growth.
• P&C business cycle is driven by supply:
• Product and consumers attitude. Stable price-inelastic demand.
4 / 66© 2010 SIA Group – www.s-i-a.ch
demand.
• Low barriers of entry (and exit). Capital (and people, IT and procedures)
• Reserving cycle (COGS not known initially, margins uncertain). Calendar year vs accident year reporting.
The industry is remarkably healthy
With the very special exception of AIG, the industry:
. has received no state aid,
. has issued very few shares,
. pays some of the highest dividend yields in the market,
. and has no solvency/regulatory issues
5 / 66© 2010 SIA Group – www.s-i-a.ch
This is probably due to:
. previous cycle’s mistakes, which have created a generalized conservative outlook
. the nature of the business model, where money is received up-front: insurance companies are sources of liquidity, while banks have been users of liquidity
All this has been true even through the worst financial crisis of the last 50 years
Apparently, low barriers to entry determine low returns
-5%
0%
5%
10%
15%
20%
25%19
52
1954
1956
1958
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
6 / 66© 2010 SIA Group – www.s-i-a.ch
1952
1954
1956
1958
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
Indus t ry R O E S & P 500
9%
11%
13%
15%
17%
19%
21%
Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07
Although returns look much better in Europe
US P&C industry ROE. Data based on average 1997-2008
16.0%
9.0%
6.6%8.3%
8%
12%
16%
20%
But there are important intra-industry differences
7 / 66© 2010 SIA Group – www.s-i-a.ch
2.5%
0%
4%
Tier 1Tier 2
Tier 3Tier 4
Mean
These differences are due to strategy, economies of scale, differentiation and the presence of a retail network
Good companies are driven by better underwriting…
Basic strategic choices can make a big difference
U.S. Propert/Casualty – Average Pretax
U.S. Propert/Casualty – Combined Ratio
Components & Gross Premiums Written
(1997 - 2006)
8 / 66© 2010 SIA Group – www.s-i-a.ch
1997-2001 soft market, 2002-04 hard, 2005-06 soft (source: AM best)
…and don’t rely on investment income
U.S. Propert/Casualty – Average Pretax
Return on Revenue & Net Investment Ratios
(1997 - 2006)
• Cycle management makes a difference, even at the expense of market share
Basic strategic choices can make a big difference
U.S. Propert/Casualty – Average Change
In Gross Premiums Written & Average Loss
Development (1997 - 2006)
9 / 66© 2010 SIA Group – www.s-i-a.ch
• Loss reserves must be conservatively managed to succeed
Diversification lowers the need for capital
Less capital for the same amount of business implies a higher ROE
Example. Diversification at Munich Re Example. Diversification at Trygvesta
Munich Re underwrites P&C, Life and Healthreinsurance and primary insurance globallyacross many different business lines.
Trygvesta underwrites general P&C insurance in Denmark and the European Nordic countries.
10 / 66© 2010 SIA Group – www.s-i-a.ch
Economies of scale also appear in actuarial and modeling expertise, as well as a business network
Specialty lines. Actuarial and modeling expertise. Economies of scale.
• Example. Euler Hermes: Specialist trade credit insurer. Credit insurance compensates policyholders when their clients fail to pay for goods or services.
• Economies of scale are obtained due to the costs of the comprehensive business intelligence associated to underwriting on a global base of customers and related trade counterparties.
11 / 66© 2010 SIA Group – www.s-i-a.ch
• Receivables collecting and credit risk services offered to customers are difficult to replicate.
The economies of scale lead to concentration. Top 5 reinsurers market share is above 50%
Reinsurance is clearly subject to economies of scale
12 / 66© 2010 SIA Group – www.s-i-a.ch
• Distribution strategy and sales channels are a competitive advantage in the retail segment.
• Example. Mapfre: multi-line insurer. 3280 branches in Spain (above 5,000 globally). See appendix.
And, for retail business, a network is hard to replicate
13 / 66© 2010 SIA Group – www.s-i-a.ch
You can find a branch close to your home or office
Conclusion
. Although P&C is a mature business with average profitability (at best), intra-industry differences indicate the possibility of sustained attractive ROEs in the low to mid-teens.
. The sector, with the notable and special exception of AIG, has received no state aid nor had liquidity problems. Most companies have paid very high, well covered dividends through the financial crisis.
. To capture those, investors must be able to discern what the real, sustainable rate is
14 / 66© 2010 SIA Group – www.s-i-a.ch
. To capture those, investors must be able to discern what the real, sustainable rate is for each individual company, and buy only when the share price presents a good entry point.
. Within a portfolio, insurance companies can, if well chose, add good performance with low volatility, for their business is uncorrelated to the overall economy, depending on its own cycle, or in random factors (catastrophes).
Main message: the Property & Casualty Insurance sector offers very good investment opportunities at current prices. Moreover, it’s likely that those opportunities will be frequent.
1. Sector Analysis
AGENDA
15 / 66© 2010 SIA Group – www.s-i-a.ch
2. SIA Analytical methodologies
3. Some specific cases
4. Conclusions
5. Q&A
Insurance company valuation
• The expected return or IRR of the investment is assessed as an average of the earnings yield (p/e ratio inverse) and ROE of a benchmark projected year.
• This could be obtained from a dividend discount model with growth given by the retained capital: (where b is the retention ratio, and g=b x ROE would be the dividends growth)
16 / 66© 2010 SIA Group – www.s-i-a.ch
• Example. Catlin: 6x p/e ratio and 11% return on equity. IRR=13.8%
• Unfortunately, this simple analysis only holds true if all parameters stay constant. To check for that sustainability, we must dig further into each company’s accounts and competitive position
To perform the analysis, we adapt the “Du Pont” methodology
• Du Pont for P&C
17 / 66© 2010 SIA Group – www.s-i-a.ch
“Du Pont” analysis
18 / 66© 2010 SIA Group – www.s-i-a.ch
Catlin: Valuation
19 / 66© 2010 SIA Group – www.s-i-a.ch
Our due diligence is made up of six steps
1. Excess equity: adequacy and adjustments
2. Reserving: adequacy and adjustments
3. Trend: current operational trends and results
20 / 66© 2010 SIA Group – www.s-i-a.ch
4. Accounting: issues affecting company financials
5. Historical ROE: five years median and variance comparison with industry.
6. Strategy: Management, Operational, Financial, Competitive position and distribution, Diversification, Other.
Economic capital analysis
• Capital analysis
• Excess capital generation is a measure of value creation.
• Excess capital is a competitive advantage. Capacity.
• Capital management (Risk adjusted return on capital) and risk profile.
21 / 66© 2010 SIA Group – www.s-i-a.ch
• Solvency and rating
Economic capital methodology
• S&P capital model
• Determines a target capital required for each risk and rating.
• Capital requirements correspond to a confidence level in the loss distribution of that risk.
• Example. An ‘A’ rating capital level corresponds to a 99,4% confidence level (or capital adequacy) for each individual risk.
22 / 66© 2010 SIA Group – www.s-i-a.ch
(or capital adequacy) for each individual risk.
• It is a multifactor model with a required capital based on underwriting (and reserving) related risks (liability risk) and investment and credit risk (asset risk) .
• Includes a diversification credit.
Capital adequacy ratio
• The capital excess/deficit is measured by the Capital Adequacy Ratio: a ratio between capital available and capital requirements or charges
23 / 66© 2010 SIA Group – www.s-i-a.ch
C1 are investment risk charges
C2 are other assets risk charges
C3 is the underwrtiting risk
C4 is the Reserve risk
C5 are other risks
Catlin: Capital adequacy ratio
24 / 66© 2010 SIA Group – www.s-i-a.ch
Catlin: asset risk charges
• The capital required for asset risk (C1 and C2 risk charges) is calculated by multiplying S&P factors to the different exposures
25 / 66© 2010 SIA Group – www.s-i-a.ch
Catlin: liability risk charges
• The premium risk (C3) is calculated by multiplying different factors to the premiums of each line of business
26 / 66© 2010 SIA Group – www.s-i-a.ch
Catlin: liability risk charges
• The reserve risk (C4) is calculated by multiplying different factors to the reserves of each line of business
• A capital charge for catastrophe risk is also added, using the 1-in-250 years loss scenario.
27 / 66© 2010 SIA Group – www.s-i-a.ch
Capital adequacy ratio
• Capital Adequacy Ratio at a BBB-rating level:
28 / 66© 2010 SIA Group – www.s-i-a.ch
Reserving analysis
• Reserves analysis
• Reserve adequacy. Redundancy or inadequacy
• Accident Year vs Calendar Year.
• Loss ratio. Prior years loss development.
• Reserving policy. Consistency
29 / 66© 2010 SIA Group – www.s-i-a.ch
• Tail (reserves duration).
• Methodology of analysis: Chain-Ladder and Bornheutter Ferguson
Catlin: Reserving analysis - Chain Ladder
• The basis for reserve estimates on a portfolio basis under the Chain-Ladder method is a triangular table in which columns represent the years when the claims originated (underwriting, accident or reporting year) and the rows represent how the claims have developed over time. The diagonals from the bottom left to the top right give the loss payments cumulated up to a specific business year
30 / 66© 2010 SIA Group – www.s-i-a.ch
Catlin: Reserving analysis - Chain Ladder
• The Future loss estimates are derived from triangles using the chain ladder method. The chain ladder method extrapolates future expected claims from claims already paid or reported using multiplication factors referred to as development factors. These factors are used to forecast the unknown part of the triangular table and measure the average increase of cumulated losses from one development year to the next. Losses usually increase the fastest during the early development years
• The reserves are then the final loss estimates minus the claims already paid as the reporting period
31 / 66© 2010 SIA Group – www.s-i-a.ch
Catlin: Reserving analysis – Bornheutter Ferguson
• Bornheutter-Ferguson method is based on Loss ratios
• Chain ladder can not be applied when there is little actual claims experience data (recent accident years). In this case, chain ladder estimates are too much influenced by recent years.
• Combines prior expectation of losses provided by simple loss ratio estimates with the actual rate of emergence of claims.
32 / 66© 2010 SIA Group – www.s-i-a.ch
Catlin: Reserving analysis – Bornheutter Ferguson
• Initial loss ratio estimate
33 / 66© 2010 SIA Group – www.s-i-a.ch
Catlin: Reserving analysis – Bornheutter Ferguson
• Using prices and losses paid for each underwriting year, we estimate a ultimate loss ratio
34 / 66© 2010 SIA Group – www.s-i-a.ch
Catlin: Reserving analysis – Bornheutter Ferguson
• Ultimate loss estimates using loss ratios are compared to corresponding losses paid and reserves.
35 / 66© 2010 SIA Group – www.s-i-a.ch
Catlin: Reserving analysis – Bornheutter Ferguson
• A weighted average of these simple loss ratio estimates and the chain-ladder results gives the Bornheutter-Ferguson figure
36 / 66© 2010 SIA Group – www.s-i-a.ch
Catlin: Reserving
37 / 66© 2010 SIA Group – www.s-i-a.ch
Catlin: Strategic
Management
Strategic plan/targets Mostly grow in a diversified fashion
Formal analysis No
Known to management Only to the extent of the simple plan mentioned
Consistent with capabilities Yes
Well comunicated Yes
Operational capability
• Company strategy analysis
38 / 66© 2010 SIA Group – www.s-i-a.ch
Operational capability
Expertise Yes
Audit and control Yes
Past performance Acceptable
Stable good management Yes
Organization fits strategy Yes
Financial Good
Targets Yes, 10%+risk free rate
Have been above targets No, but period was bad (KRW)
Conservative accounting Acceptable
Catlin: Strategic
Diversification
Geographic Yes, and growing. But it is new: some dangers of lack of expertise
Product Not much. Focused on plain P&C, developingsome niche expertise
Distribution
Loyalty Not much (brokers)
Effectiveness Normal
39 / 66© 2010 SIA Group – www.s-i-a.ch
Cost efficient Normal
Market share Not great
Cost advantage Does not show
High share in good markets Weak
Low threat of newcomers Weak
Other
Take-over advantages Wellington was ok, some synergies but mostlytax and financial; less so operating ones
Main message: the Property & Casualty Insurance sector offers very good investment opportunities at current prices. Moreover, it’s likely that those opportunities will be frequent.
1. Sector Analysis
AGENDA
40 / 66© 2010 SIA Group – www.s-i-a.ch
2. SIA Analytical methodologies
3. Some specific cases
4. Conclusions
5. Q&A
• Example. PMI Group Inc: Residential mortgage insurer, providing loss protection to mortgage lenders and investors in the event of borrower default.
PMI: the early warning
41 / 66© 2010 SIA Group – www.s-i-a.ch
PMI: the early warning
42 / 66© 2010 SIA Group – www.s-i-a.ch
AIG: Underpricing
Workers Comp, 23.7%
All Other, 32.5%
2006 AIG Statutory P/C Reserves - $53B
• Other liabilities chain-ladder 2006 estimate
• Example. AIG Inc. The reserve adequacy of AIG back in 2006 was just enough, and below industry.
43 / 66© 2010 SIA Group – www.s-i-a.ch
Other Liability, 43.8%
• 2006 Total Redundancies on reserves: (593)MM Other Liability + 797MM WC + 188MM All Other = $392MM redundancy (0.7% of reserves). Well below large carriers: 8.5% redundancy at ACE, Hartford and Chubb. Below industry: 2% redundancy.
AIG: Underpricing
• Reserves at the end of 2008 were deficient.
44 / 66© 2010 SIA Group – www.s-i-a.ch
AIG: Underpricing
• Other lines segment includes Financial and Mortgage Guaranty. Premiums: 576mio (2007), 655mio (2008). Booked Loss ratio: 250%. Loss: 1,6bio
45 / 66© 2010 SIA Group – www.s-i-a.ch
AIG: Underpricing
• Loss ratio booked in 2008 neither looks conservative in the current soft market.
46 / 66© 2010 SIA Group – www.s-i-a.ch
Main message: the Property & Casualty Insurance sector offers very good investment opportunities at current prices. Moreover, it’s likely that those opportunities will be frequent.
1. Sector Analysis
AGENDA
47 / 66© 2010 SIA Group – www.s-i-a.ch
2. SIA Analytical methodologies
3. Some specific cases
4. Conclusions
5. Q&A
The P&C insurance sector is stable and with an uncorrelated cycle to the economy
Average profitability hides wide intra-industry differences
Those differences can be captured ex-ante with the right analytical tools
Conclusions
48 / 66© 2010 SIA Group – www.s-i-a.ch
Addition to P&C insurance and reinsurance companies to a portfolio can increase its risk-adjusted returns
Main message: the Property & Casualty Insurance sector offers very good investment opportunities at current prices. Moreover, it’s likely that those opportunities will be frequent.
1. Sector Analysis
AGENDA
49 / 66© 2010 SIA Group – www.s-i-a.ch
2. SIA Analytical methodologies
3. Some specific cases
4. Conclusions
5. Q&A
Appendices
50 / 66© 2010 SIA Group – www.s-i-a.ch
• Euler Hermes share price and the credit cycle (2005-09).
Appendix: Euler Hermes
51 / 66© 2010 SIA Group – www.s-i-a.ch
Euler Hermes shares, iTraxx CDS main
• Euler Hermes and the economic cycle (1998-2009)
Appendix: Euler Hermes
52 / 66© 2010 SIA Group – www.s-i-a.ch
Combined ratio
• Financial flexibility and liquidity can be a barrier of entry.
• Example. Life insurance/reinsurance can generate funding needs: regulatory reserve requirements above actuarial estimates for some segments (see US level term), DAC funding.
• P&C and Life businesses show financial synergies and economies of scale both from capital and funding needs.
• Example. Scottish Re.
Appendix: Scottish Re
53 / 66© 2010 SIA Group – www.s-i-a.ch
• Life reinsurer with an agressive growth strategy until 2006 (3rd US player), when it suffered a liquidity crisis. They relied in a securitization market funding strategy to do acquisitions, like the ING Re business bought in 2004. They raised private capital in December 2006, but in 2007 they experienced losses due to their structured credit exposures.
• In January 2009, the ING Re business was sold to Hannover Re (a P&C and Life reinsurer)
• Chart from a 2005 Scottish Re presentation
Appendix: Scottish Re
54 / 66© 2010 SIA Group – www.s-i-a.ch
• Claims management can be a competitive advantage.
• Example. ProAssurance Corporation. Specialty medical professional liability insurer in the US.
Appendix: ProAssurance
55 / 66© 2010 SIA Group – www.s-i-a.ch
• ProAssurance Corporation claims management compared to the industry. Claims defence skills is a differentiation factor.
Appendix: ProAssurance
56 / 66© 2010 SIA Group – www.s-i-a.ch
• ProAssurance Corporation and the Med-mal supply-driven cycle
Appendix: ProAssurance
57 / 66© 2010 SIA Group – www.s-i-a.ch
• Cap Gemini World Insurance Report 2008. Purchase criteria.
Appendix: Cap Gemini survey
58 / 66© 2010 SIA Group – www.s-i-a.ch
• Product and advisory services differentiation is higher in other insurance segments like Life and Health.
• Mapfre operating ratios compared to the sector
Appendix: Mapfre
59 / 66© 2010 SIA Group – www.s-i-a.ch
• Mapfre operating results
Appendix: Mapfre
60 / 66© 2010 SIA Group – www.s-i-a.ch
• The expected return of an investment in a Life business is assessed using the recurrent earnings and the IRR of the equity shareholder’s cash-flows for a benchmark year. The Embedded Value report is a good source of this information.
• Example: Allianz
• The profit is measured using the expected business contribution (which is equal to the unwinding of the embedded value). This was some 2000 mio in 2009.
Appendix: Life insurance
61 / 66© 2010 SIA Group – www.s-i-a.ch
• Example: Allianz (continued)
• The shareholder’s equity IRR from the existing business in-force can be obtained from the cash-flow release report. It is the discount rate of the cash-flows that equals the embedded value (adjusted by adding back to it the TVFOG, CRNHR and FC and subtracting the Free surplus). Using 2009 data, the IRR is about 6%.
Appendix: Life insurance
62 / 66© 2010 SIA Group – www.s-i-a.ch
• Some further considerations on the analysis:
• TVOGs: time value of options and guarantees granted to policyholders. Expected earnings include the release of this cost (incurred in a more risk-neutral world). Similar considerations for CNRHR, FC items.
• NAV as a percentatge of Embedded Value. A small figure means more value in-force (future profits) for a given equity investment (NAV).
• New business margin. The in-force IRR can be a misleading guide to future returns if new business margins differ significantly from in-force.
Appendix: Life insurance
63 / 66© 2010 SIA Group – www.s-i-a.ch
business margins differ significantly from in-force.
• Earnings volatility and sensitivities to risk factors. We check the accounts volatility and the embedded value sensitivities to risk factors.
• Debt leverage at the group level can improve the ROE (and therefore the expected return) in a diversified mixed insurance company (economy of scale).
• Example: Allianz (continued)
Appendix: Life insurance
64 / 66© 2010 SIA Group – www.s-i-a.ch
• Example: Mapfre
Appendix: Life insurance
65 / 66© 2010 SIA Group – www.s-i-a.ch
• Example: Mapfre
Appendix: Life insurance
66 / 66© 2010 SIA Group – www.s-i-a.ch