A Shareholder Value Analysis of the Global (Re)insurance Industry

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A Shareholder Value Analysis of the Global (Re)insurance Industry A Shareholder Value Analysis of The Global (Re)insurance Industry Commissioned by Contents Foreword Executive summary 1 Defining the global
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A Shareholder Value Analysis of the Global (Re)insurance Industry A Shareholder Value Analysis of The Global (Re)insurance Industry Commissioned by Contents Foreword Executive summary 1 Defining the global general (re)insurance sector 2 Analysing financial performance 3 Analysing strength and capacity 4 The impact of Cat 9/11 5 The impact of latent liabilities 6 Renewed focus on governance 7 Profiles on special markets 8 Data and methods The source of all financial data was corporate annual reports and financial statements (2001). The cut-off date for this research was 12 February Foreword The insurance and reinsurance industry is a fascinating world of which to be a part. The dynamics of the industry seem ever-changing the risks that insureds have to deal with and the challenges that insurers face in balancing their assets and liabilities. I have experienced several soft/hard market cycles, but I truly believe that the current market conditions are unprecedented both with respect to cause and effect. The WTC disaster crystallised the already hardening market not just because of the financial cost, but also because of the nature of the event and the scale and scope of losses suffered. This then coincided with the severe meltdown in the world s investment markets over the last couple of years. Oxford Metrica analysed this phenomenon in a report previously commissioned by Aon, Insurance and the Stock Market The Asset Test. We think it is now time to take a wider view of the issues facing the global non-life insurance industry, and have asked Oxford Metrica to conduct a detailed value analysis and to examine the key issues facing the industry. We are pleased to share their analysis with you, and trust that you will find the results informative and thought-provoking, as all the participants in the industry struggle to chart a strategic course through the perfect storm. Dennis L. Mahoney Chairman and Chief Executive Officer Aon Limited 3 Executive Summary The aim of this briefing is to provide an independent, rigorous analysis of the performance of the global general (re)insurance market. The key results and policy implications of the research are outlined below. Key Results: Twenty-five firms (the Top25) dominate the global (re)insurance market, with a combined market capitalisation of over US$500 billion. These firms adopt a wide range of strategies as regards: governance policy, globalisation, reinsurance purchase, underwriting decisions and investment allocation. Twenty-three firms of the Top25 portfolio lost money on their general (re)insurance underwriting operations in Despite a wave of downward rating action by the main rating agencies, the industry remains strong, with eleven firms in the Top25 each with a balance sheet of over US$50 billion. Newer, smaller, US and Bermudian firms staged the strongest value recovery post- 9/11. Older, larger, European firms underperformed significantly. Substantial asbestos claims continue to hound the industry, with rising corporate liability claims also posing a major threat. There is a disturbingly wide range in financial reporting standards adopted by firms across the industry. Policy Implications: Stricter, more economic underwriting decisions are essential for the continued survival of the industry. The equity markets can no longer be relied upon to generate the healthy investment returns seen in the 1990s. Additional reserve increases will be necessary for many firms facing the weight of growing asbestos and corporate liability claims. There is a clear need for more, and better quality, disclosure in financial reporting, particularly in Europe. 4 1 Defining the Global General (Re)insurance Sector The subject of this briefing is the global general (re)insurance sector. This is defined as quoted firms that write general (non-life, property-casualty) reinsurance or insurance on a global basis as a major line of business. How is value distributed? Figure 1 shows the breakdown by primary type of business of the 484 quoted firms worldwide that write insurance as a main activity. These firms have a combined market value of US$1.061 trillion. Figure 1: The Value Landscape (3 Jan 2003) Domestic General Reinsurers (12) 0.3% US$2.7bn Domestic General Insurers (299) 21.5% US$228.6bn US$365.6bn Life Assurers (120) 27.1% US$287.6bn US$176.8bn Global General Insurers (34) 34.4% Global General Reinsurers (19) 16.7% Approximately one-quarter of this value comes from the life assurance sector. A second quarter is represented by general insurers and reinsurers that focus exclusively on domestic business. The remaining US$542.4 billion represents 34 general insurers and 19 reinsurers that write global business. It can be seen from Figure 1 that the distribution of value is very different across each subsector. Value across the 53 global general firms is much more concentrated than for either domestic firms (311) or life assurers (120) where the markets are more fragmented. For example, contrast 299 domestic general insurers with a combined market value of US$228.6 billion with just 34 global general insurers with a combined market value of US$365.6 billion. Figure 2a focuses on global general (re)insurers and shows that the industry concentration is even more pronounced than at first observation. Of the 53 separately quoted entities represented in this subsector, 25 (with their subsidiaries) account for over 97% of the value. It is on these Top25 firms that this Briefing shall focus explicitly. 5 Figure 2a: The Value Dominance of the Top25 (3 Jan 2003) Top25 Subsidiaries (14) 4.1% US$22.1bn Other Global (Re)insurers (14) 2.6% US$14.2bn US$506.1bn Top % Figure 2b illustrates the value progression of the Top25 portfolio over time, against the S&P500 Composite market index. Figure 2b: The Value Pattern of the Top25 (11 Sep Feb 2003) 800 1,400 Top25 MCap (US$ billion) Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec-02 Of the remaining 2.6% of value, 65% is accounted for by Travelers Property Casualty (previously a wholly-owned subsidiary of Citigroup) and Converium (previously the reinsurance arm of Zurich Financial Services) for which annual financial statements have yet to be published. A further 20% (of the 2.6%) is accounted for by five Lloyd s managing agents. These are profiled separately in Section 7. This leaves seven firms, 6 11-Jan Feb-03 1,200 1, S&P500 Composite each with a market capitalisation of under US$1 billion that, together, represent less than 0.4% of the global general (re)insurance market. Listed in Table 1 are the Top25 firms selected for study. On 3 January 2003, these firms had a combined market value of over US$500 billion. Table 1: The Top25 Global (Re)insurers Company Type of Business Country MCap (US$m) on 3 Jan 2003 AIG Insurer US 156,829 Berkshire Hathaway Reinsurer US 110,443 ING Group Insurer Netherlands 34,871 Allianz Insurer Germany 26,975 Generali Insurer Italy 26,736 AXA Insurer France 26,064 Munich Re Reinsurer Germany 22,705 Swiss Re Reinsurer Switzerland 22,423 Zurich Financial Insurer Switzerland 14,573 XL Capital Insurer Bermuda 10,828 Chubb Insurer US 9,371 The St. Paul Insurer US 7,937 ACE Insurer Bermuda 7,102 CNA Financial Insurer US 5,917 Transatlantic Hdgs. Reinsurer US 3,592 Royal & SunAlliance Insurer UK 2,937 QBE Insurance Insurer Australia 2,844 Partner Re Reinsurer Bermuda 2,626 Everest Re Reinsurer US 2,582 Hannover Re Reinsurer Germany 2,500 Renaissance Re Reinsurer Bermuda 2,216 IPC Holdings Reinsurer Bermuda 1,537 Odyssey Re Reinsurer US 1,153 SCOR Reinsurer France 767 Max Re Capital Reinsurer Bermuda 547 Total 506,075 The Top25 portfolio was defined on 30 June 2002, though Table 1 presents updated values. The portfolio comprises twelve reinsurers and thirteen insurers. Ten firms are European, eight are American, six are Bermudian and one is Australian. Which are the dominant firms? Figure 3 illustrates exactly the same subsector as shown in Figure 2a but broken down by company. Clearly, the market values illustrated reflect non-insurance activities also. In value terms, AIG has almost one-third of the combined market value of the global market for general insurance and reinsurance. AIG s 60% ownership of Transatlantic Holdings and 24.4% ownership of IPC Holdings is reflected in the chart. Were it not to be reflected, AIG s value share would reduce slightly to 28.9%. 7 Figure 3: The Value Distribution by Company (3 Jan 2003) Zurich Financial 2.7% Swiss Re 4.1% Munich Re 4.2% Other 18.1% AIG 29.4% AXA 4.8% Generali 4.9% Allianz 5.0% ING Group 6.4% Berkshire Hathaway 20.4% The share of the value pie of both Allianz and Munich Re has reduced over the previous six months; from 8.2% and 6.5%, respectively. Berkshire Hathaway has increased its share from 15.8% to 20.4%. The other firms illustrated have remained largely constant. However, value is but one measure of dominance and reflects also non-insurance activities. Presented in Figure 4 is the distribution of total gross premiums written across the major firms. The distribution is almost identical to that for net premiums written with the exception of Zurich Financial which cedes a higher than average proportion of its premium volume. Comparison of Figures 3 and 4 reveals the very different value multiples at which these firms trade. Figure 4: Distribution of Total Gross Premiums Written (2001) Berkshire Hathaway 4.4% Swiss Re 3.8% Others from Top % AXA 13.8% Allianz 12.2% Royal & Sun Alliance 4.6% Zurich Financial 7.0% Munich Re 7.2% Generali 9.0% ING Group 10.0% AIG 11.1% 8 Berkshire Hathaway s strong value presence is not reflected in the distribution of total premium volume. In 2001, the firm derived approximately 43% of its annual operating revenue from non-insurance activities. However, a focus on general insurance in Figure 5 reveals a more prominent ranking for Berkshire. The graph shows the gross premiums written specifically for general insurance business across the Top25 global insurers and reinsurers. Figure 5: Gross Premiums Written for General Insurance Allianz AIG Zurich Financial AXA Munich Re Berkshire Hathaway Royal & SunAlliance Generali Swiss Re CNA Financial The St. Paul ACE Hannover Re Chubb ING Group XL Capital QBE Insurance SCOR Transatlantic Holdings Everest Re Partner Re Odyssey Re Renaissance Re Max Re IPC Holdings Net Premiums Written Ceded The disappearance of ING Group from the top four global players is reflective of its extensive life operations. Figure 6 illustrates the range in reinsurance strategies adopted; ranging from Partner Re which cedes 2% of its premium income, to CNA Financial 1 which cedes 49%. No firm in the Top25 cedes more than 50% of its premium volume. Figure 6: Allocation of GPW for General Insurance (%) US$ billions Partner Re IPC Holdings Berkshire Hathaway Generali ING Group AXA Chubb Odyssey Re Allianz SCOR Munich Re Everest Re Max Re Transatlantic The St. Paul Royal&SunAlliance Zurich Financial Swiss Re QBE Insurance AIG Renaissance Re Hannover Re XL Capital ACE CNA Financial 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 1 CNA Financial is 89% owned by Loews Corporation. Net Premiums Written 9 Ceded The reinsurance strategy adopted by management appears to have little to do with whether the firm primarily is a reinsurer or insurer. Nor does sheer size appear to be a determining factor, with AIG and Berkshire Hathaway emerging towards either end of the ranking. The decision of how much premium to cede to reinsurers (determining the ceding ratio) essentially reflects discretionary policy by management and, when applied effectively, can be a source of great competitive advantage. The advantage is derived more from effective implementation than from the ceding ratio itself. Shown in Figure 7 for the Top25 firms are the total net premiums written across both life assurance and general (re)insurance operations. Immediately apparent are the extensive life operations of AXA, ING Group, Generali, AIG and Allianz yet the latter two firms still occupy the top two places in the ranking for general insurance. Allianz AIG Zurich Financial Berkshire Hathaway AXA Munich Re Generali Royal & SunAlliance Swiss Re The St. Paul Chubb ACE CNA Financial Hannover Re ING Group XL Capital SCOR QBE Insurance Transatlantic Holdings Partner Re Everest Re Odyssey Re Max Re Renaissance Re IPC Holdings Figure 7: Total Net Premiums Written General Life US$ billions Figure 8 shows the proportional allocation of total net premiums written. Nine firms from the Top25 offer general (re)insurance exclusively. Of the remaining firms, there is a wide range in the extent to which they focus on general business. For ACE, general insurance business forms 94% of its total book whereas for ING Group, the comparative figure is 11%. 10 Figure 8: Allocation of Total NPW (%) Everest Re IPC Holdings Odyssey Re QBE Insurance Renaissance Re The St. Paul Transatlantic Holdings XL Capital Chubb ACE Partner Re Berkshire Hathaway Hannover Re SCOR Royal & SunAlliance Zurich Financial Max Re Allianz Swiss Re CNA Financial Munich Re AIG Generali AXA ING Group 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% General Similarly, there is a very wide range in the extent to which the Top25 firms underwrite a global portfolio of general business; illustrated in Figure 9. Clearly, the smaller the domestic 2 country of a parent company, the greater the need to expand to foreign climes to generate premium volume. Thus it is of little surprise to see the Swiss heading the globalisation ranking and the Americans with a much higher proportion of their business in domestic operations. Swiss Re generates 95% of its premium volume from outside Switzerland. CNA Financial generates only 5% of its premiums from outside the US. Life Figure 9: Geographical Allocation of General NPW (%) Swiss Re Zurich Financial ACE ING Group QBE Insurance Hannover Re XL Capital AXA Allianz Generali SCOR Royal & SunAlliance Partner Re IPC Holdings Munich Re Renaissance Re Transatlantic Holdings Odyssey Re Max Re AIG Berkshire Hathaway Everest Re The St. Paul Chubb CNA Financial 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Domestic Foreign 2 The Bermudian firms define their domestic operations differently from each other. ACE and XL Capital both define domestic as Bermuda; IPC Holdings defines it as the US; Renaissance Re defines it as the US and Bermuda; and both Partner Re and Max Re define domestic as North America. 11 Eight firms produce less than 50% of their general net premiums from outwith their domestic country. The geographical allocation of total net premiums written is very similar to that of general insurance shown in Figure 9, with two notable exceptions. Zurich Financial s extensive life operations in Switzerland raise the proportion that is domestic to 15% of its total book. In contrast, AIG s strong international life operations increase the foreign proportion of its total business to almost 50%. 12 2 Analysing Financial Performance The underwriting losses of insurers have been aggravated by widespread falling stock values, reducing insurers ability to produce impressive results from the contribution of strong investment returns. Figure 10 illustrates the loss and expense ratios across the Top25 firms for the 2001 financial year. The combined ratios are calculated as the sum of two quotients; losses and loss-adjustment expenses as a proportion of net earned premiums (the loss ratio), and underwriting expenses and policy acquisition costs as a proportion of net earned premium (the expense ratio). The combined ratios calculated focus on the general insurance business written by each firm. Only Renaissance Re (70.2%) and AIG (99.6%) manage to achieve a combined ratio of less than 100%. Figure 10: Combined Ratios Renaissance Re AIG Zurich Financial ING Group Generali QBE Insurance Allianz Max Re ACE AXA Everest Re Chubb Royal & SunAlliance Transatlantic Hdgs. Odyssey Re Hannover Swiss Re Berkshire Hathaway IPC Holdings Munich Re SCOR Partner Re The St. Paul XL Capital CNA Financial 0% 20% 40% 60% 80% 100% 120% 140% 160% Loss ratio Expense ratio Ranked in Table 2 are the best and worst results when disaggregated into loss and expense ratios. It can be seen that Renaissance Re achieves first place in the combined ratio ranking due to an extremely low loss ratio of 45%. AIG appears as a top performer both in achieving a loss ratio of under 80% and an expense ratio of under 20%. Despite having the lowest expense ratio, at 10%, Max Re s combined ratio is negatively affected by its particularly high loss ratio of over 100%. IPC Holdings and Berkshire Hathaway also enjoy low expense ratios but have been adversely affected by high loss ratios. CNA Financial s expense ratio is extreme, at 54%. Both The St. Paul Companies and XL Capital appear towards the lower end of the rankings for both loss and expense ratios. 13 Table 2: Loss and Expense Ratios - The Tails of the Distribution Loss Ratios Expense Ratios 80% 100% 20% 30% Renaissance Re 45.0% IPC Holdings 111.5% Max Re 10.3% CNA Fin l 53.5% ING Group 74.8% Berkshire H % Hannover Re 16.3% The St. Paul 39.7% QBE Ins. 76.6% XL Capital 105.0% Zurich Fin l 17.3% XL Capital 38.2% Generali 79.5% The St. Paul 102.5% IPC Holdings 17.9% Odyssey Re 34.8% AIG 79.6% Max Re 100.8% Berkshire H. 19.1% Chubb 33.9% SCOR 100.6% AIG 19.9% QBE Ins. 33.0% Partner Re 100.4% Munich Re 31.7% Everest Re 31.0% RSA 30.3% Figure 11 shows the insurance performance by each firm. This is defined as the difference between reported net income and the net investment result (net investment income after interest paid), as a proportion of net earned premiums. Figure 11: Insurance Performance Renaissance Re Allianz QBE Insurance Everest Re ING Group ACE Chubb Transatlantic Hdgs. AIG Hannover AXA Max Re Odyssey Re SCOR Berkshire Hathaway Zurich Financial Generali Partner Re XL Capital The St. Paul IPC Holdings Munich Re Swiss Re Royal&SunAlliance CNA Financial -50% -40% -30% -20% -10% 0% 10% 20% 30% Other than Renaissance Re, each constituent of the Top25 portfolio made a loss from its overall, underlying operations in Both CNA Financial and Royal & SunAlliance perform poorly without the benefit of investment income. This is reflected also as regards cash flow performance 3, presented in Figures 12 and 13. Cash flow performance is defined as operating cash flow as a proportion of net earned premiums. 3 Generali does not disclose an annual statement of cash flows and so is excluded from Figures 12 and Figure 12: Cash Flow Performance Max Re Renaissance Re IPC Holdings ING Group XL Capital ACE Berkshire Hathaway Everest Re Partner Re Hannover AXA Chubb Transatlantic Hdgs. The St. Paul QBE Insurance Munich Re Allianz AIG SCOR Odyssey Re Swiss Re Zurich Financial Royal & SunAlliance CNA Financial -40% -20% 0% 20% 40% 60% 80% Figure 13 shows the excess of operating cash flow over net income. The graph illustrates the magnitude of non-cash charges recognised in the income statements of these firms and demonstrates the degree of discretion afforded to insurance companies in their financial reporting. Figure 13: The Cash-Earnings Gap ING Group AXA Munich Re Berkshire Hathaway AIG The St. Paul XL Capital Swiss Re Royal & SunAlliance ACE CNA Financial Hannover Chubb Partner Re Max Re Everest Re SCOR Transatlantic Hdgs. Renaissance Re QBE Insurance IPC Holdings Odyssey Re Zurich Financial Allianz US$ billions When investment returns are examined, CNA Financial is the top performer and Royal & SunAlliance also appears in the top five, both achieving returns of over 7%. Investment returns are defined as net investment income as a proportion of total investments and cash. No firm in the portfolio achieves investment returns of beyond 15 10%. Given the dire state of the equity markets, it is impressive that each firm has managed to generate a positive return. Figure 14: Investment Returns CNA Financial Swiss Re Ha
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