As an industry, the property casualty sector had been trading at a discount to book value for more than four years, far longer than any prior period. However, year-to-date 2013 performance has pushed the property-casualty group to book value multiples exceeding 1.00, valuations not seen in the industry since early 2009. This study provides a long-term perspective on returns and valuations in the property casualty industry, approaches to valuation, total returns and value creation. We analyze valuations by subsector and provide rankings based on value creation.
2. Executive Summary
3. Returns and Valuations—A Long-Term Perspective
- Historical Valuations—Overview
- The Effect of Leverage
- Underwriting Cycles—More Downside, Less Upside
- The Role of Interest Rates
4. Approaches to Valuation
- Summary of Valuation Techniques
- Economic Value
- Discounted Cash Flow
- Market Values
- “Float” Analysis
5. Total Returns and Value Creation
- Dividends and Total Returns
- Contributions to Surplus Growth
- Risk and Return Analysis
- Target ROE Analysis
6. Sector Analysis and Comparison to Other Financial Services
- Valuations by Subsector
- Stock Companies versus Mutuals
- Performance Versus Other Financial Services
7. Value Creation and Performance Rankings
- Rankings for Stock Companies
- Rankings for Mutual Companies
A. Property-Casualty Insurance Stocks—Summary Market Information
B. Value Creation Rankings
When we began our research and writing for this study, the universe of publicly traded property-casualty stocks was well into year four of trading below stated book value, as a group. However, year-to-date 2013 performance has pushed the property-casualty group to book value multiples exceeding 1.00, valuations that had not been seen as an industry since early 2009.
The original premise of the study was to review the conditions that could lead to such a dismal level of valuation being assigned to this industry, and for such an extended period. With values now above book value, our question is less about why the discount and more about whether we have reached a new equilibrium or “new normal” for valuations. We also find it instructive to review some of the longer-term trends that affect value creation, and by extension, market values.
Will the property-casualty industry valuations, as represented by an index of the public companies, remain above book value? Improved growth and profitability prospects suggest that the sector should be valued at least at its stated book value. Although we are not “stock pickers” we do think we have insights into long-term drivers of value creation.
We believe the best measure of value creation is growth in book value (or surplus) plus dividends paid. Because this analysis is most applicable to stock companies, which can pay shareholder dividends, a majority of our analysis is centered around the stock company universe that makes up approximately 70% of the industry. This value creation metric is also applicable to mutual companies, and we do devote a meaningful portion of our analysis to a comparison of stock versus mutual insurers.
One way to think of the value of a property-casualty company (or the industry) is as a leveraged (primarily fixed income) investment portfolio—the key word being leverage. As Berkshire Hathaway describes in its float analysis, the cost of that leverage is how much underwriting loss is incurred to access it.
Another approach to value is to consider the service aspect of what the insurance industry provides, thereby taking into account potential franchise value. In this regard, insurance is not just viewed as a pool of capital, but includes the value of underwriting expertise, claims service, brand, and distribution, and importantly how that translates into improved performance.
Chapter 3 provides a long-term perspective on valuations and returns, concentrating on what we think are the key factors influencing the industry’s ability to generate returns on its capital. These factors include the long-term effect of declining leverage, underwriting cycles, volatility, and the role of interest rates. In Chapter 4, we review the various valuation methodologies we have used including economic value, discounted cash flow analysis, various measures of market value, and a float analysis.
In Chapter 5, we analyze returns and value creation in greater detail. We examine the industry’s capital management history, including dividends and capital raising, as well as the sources of surplus growth. We also look at the relationship between return and risk—how much risk was involved in the value creation process.
Chapter 6 provides a more granular view, moving from an industry analysis to a look at valuation differences among the subsectors that compose the property-casualty industry. We also devote some analysis to performance and value creation differences between stock and mutual companies, as well as to a comparison of the property-casualty industry to other financial services sectors. We conclude in Chapter 7 with a ranking analysis for the top-performing groups as measured by value creation over a ten-year period, for both stock and mutual companies.