March 14th, 2012

Capital Management: Reinsurance Valuations at a Long-Term Low

Posted at 1:00 AM ET

The challenging macroeconomic environment of subdued growth and low interest rates meant the reinsurance sector ended 2011 trading near 20-year lows. As Figure 1 illustrates, the average price to book ratio for the sector of 0.893 is just greater than one and a half standard deviations down from the 20-year average of 1.32. The sovereign debt crisis, threat of a double-dip recession, heavy non-peak zone catastrophe losses during 2011 and concerns about reserve adequacy are among the factors contributing to volatility and low valuations. Additionally, despite the heavy losses incurred during 2011, many reinsurers are still perceived to have excess capital relative to projected earnings and top-line growth.

Figure 1

4_Historical Global P&C Reinsurer Valuation

Reinsurers have been buying back shares in large amounts over the last few years, due in part to low valuations. Share buybacks provide a means for (re)insurance management to strategically manage their capital and help increase return on equity (ROE). Buybacks for the Guy Carpenter Global Reinsurance Composite topped USD10.5 billion in 2010. Repurchases continued to be strong at the beginning of 2011 but ceased entirely during the second and third quarters as claims from Australia, New Zealand and Japan were filed. Predictions for an active hurricane season also called for restraint in returning capital.

Nevertheless, following a relatively benign hurricane loss season, several reinsurers announced substantial balances to be returned to shareholders in the fourth quarter. However, most of these companies had not yet completed these share buybacks by year-end.

As noted in the next post, low valuations, for a number of reasons, are not contributing significantly to M&A deals despite the outlook for higher returns in 2012. However, a turn in the pricing cycle would help to drive an increase in both valuations and M&A activity.

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