Tag Archives: operating ROE

Insurance ROEs earned the hard way

Munich kicked off the year end reporting season for insurers this week with a pre-announcement of results that beat their guidance. For non-life reinsurance, low large and catastrophe losses plus 5% of prior year releases mean that the 92% combined ratio is only 1% higher than 2012 for Munich Re despite the weak pricing market.

I am expecting to see strong non-life results across the market as it looks like attritional loss ratios for 2013 are lower than average which, with low catastrophe losses, should make for low combined ratios in 2013.

For specialty nonlife insurers and reinsurers, I would expect combined ratios to come in the mid to high eighties on average with ROEs in the low to mid teens. The relatively low investment returns are hurting ROEs which in the past would of given high teens or low twenties for such underwriting ratios.

The business models of the European composite reinsurers are not as sensitive to combined ratio with the life side providing more stable earnings. I would expect most of the large composite reinsurers to come in in the low 90s or high 80s (Munich’s figure was 92%) whilst giving ROEs similar to their non-life specialty brothers in the low to mid teens.

The graph below illustrates that todays combined ratios don’t mean the high ROEs they once did (2013 figures are as at Q3).

click to enlargeInsurance ROEs and Combined Ratios 2004 to 2013


Historical Price to Tangible Book Value for Reinsurers and Wholesale Insurers

Following on from the previous post, the graph below shows the historical P/TBV ratios for selected reinsurers and wholesale insurers with a portfolio including material books of reinsurance (company names as per previous post). The trend shows the recent uptick in valuations highlighted in the previous post. The graph is also consistent with the Guy Carpenter price to book value graph widely used in industry presentations.

Historical P to TBV Reinsurers & Wholesale Insurers 2001 to 2013Over the past 12 months the sector has broken out of the downward trend across the financial services sector following the financial crisis, most notably in the banking sector as the graph below from TT International illustrates.

TT International Bank Price to Book Ratio

Tangible book value growth across the wholesale insurance sector was approximately 10% from YE2011 to YE2012 and the weighted average operating ROE of 11% in 2012 has been rewarded with higher multiples.

The sector faces a number of significant issues and a return to valuations prior to the financial crisis remains unrealistic. An increase in capacity from non-traditional sources and the increased loss costs from catastrophes are cited in industry outlooks as headwinds although I tend to agree with EIOPA’s recently published risk dashboard in highlighting the impact of macro-economic risks on insurer’s balance sheets as the major headwind.

One issue that deserves further attention in this regard is the impact low interest rates have had on boasting unrealised gains and the resulting impact on the growth in book values. Swiss Re is one of the few companies to explicitly highlight the role of unrealised gains in its annual report, making up approximately 13% of its equity. In a presentation in September 2012, the company had an interesting slide on the impact of unrealised gains on the sector’s capital levels, reproduced below.

Reinsurer Capital & Unrealised Gains

P/TBV is one of my favoured metrics for looking at insurance valuations. But no one metric should be looked at in isolation. The impact of any sudden unwinding of unrealised gains if the macro environment turns nasty is just one of the issues facing the sector which deserves a deeper analysis.