How Investment Bankers Value Insurance Companies - PowerPoint PPT Presentation

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How Investment Bankers Value Insurance Companies

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Title: How Investment Bankers Value Insurance Companies


1
How Investment Bankers Value Insurance Companies
  • Valuation of Insurance Operations
  • April 10

Casualty Actuarial Society
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In Todays Market
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Two Approaches
  • Market Approach
  • Fundamental Approach
  • Traditional Approach
  • Non-traditional Approach

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Market Approach
  • Research Analyst
  • Buy-side Analyst
  • Investor Community

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Market Approach
  • Valuations for property casualty insurance
    companies have declined significantly during the
    past year
  • The decline in the property casualty sector is
    the result of deterioration in the industry
    fundamentals that drive value

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Market Approach
  • Volatility of the industrys results has declined
    over the last twenty years

Volatility of Property Casualty Earnings
4.0x
3.5x
3.0x
2.5x
2.0x
Standard Deviation
1.5x
1.0x
0.5x
0.0x
1942-
1947-
1952-
1957-
1962-
1967-
1972-
1977-
1982-
1987-
1992-
46
51
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81
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96
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Which operating factors drive stock market values?
  • Profitability, as measured by return on equity
  • Profit margin
  • Operating leverage
  • Earnings consistency
  • Standard deviation of change in earnings
  • Reserve development
  • In other words, the market rewards risk adjusted
    returns on capital

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Value Drivers
Price/Book Price/Book
Baldwin Lyons, Inc. 0.79x
W.R. Berkley Corporation 0.65
Capitol Transamerica Corp. 1.00
HCC Insurance Holdings, Inc. 1.31
Markel Corporation 1.74
Medical Assurance, Inc. 1.40
NYMAGIC, Inc. 0.52
Penn-America Group, Inc. 0.78
Philadelphia Cons. Holding Co. 1.13
RLI Corp. 0.93
Return on Equity Earnings Consistency Earnings
Growth
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Value Drivers
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Value Drivers
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Value Drivers
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Who Cares about the Actuaries
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Frontier Chart
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Meadowbrook Chart
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Consolidation and the Need for Economies of Scale
  • Opportunities for convergence
  • Need for multiple distribution channels
  • Need for broader line of products
  • Need to achieve greater efficiencies
  • Need to minimize rating pressures
  • Need for improved access to capital

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Increased Consumer Awareness
  • Consumers more informed through internet
  • More product choices and distribution methods
    increase awareness
  • Privacy issues becoming more significant
  • Consumers becoming informed about structural
    alternatives (such as demutualization)

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Margin Erosion
  • Commodity products (e.g. term insurance, auto)
  • New entrants
  • Widespread consumer information
  • Competitive pressures increasing loss ratios
  • High cost distribution systems

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Rating Pressures and Capital Requirements
  • Eroding profits or growth rates put pressure on
    ratings
  • Low rates of return on equity
  • Some companies have high loss ratios reserves
    need strengthening

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Fundamental Analysis
  • We traditionally base our valuation of insurance
    companies on four valuation methodologies
  • Analysis of public market comparables
  • Private and public market MA transactions
  • Discounted cash flow analysis
  • Additional areas of value that must be developed
    with potential buyers

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Comparable Company Analysis
  • We focus our multiple analysis on Price/Earnings
    and Price/Book multiples. In analyzing these
    multiples, we consider the following factors
  • Core earnings power of the Company
  • Earnings growth compared to the comparable
    companies
  • Relationship between price to book value and
    return on equity

Casualty Actuarial Society
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MA Transactions Analysis
  • Additionally, we analyze recent private and
    public market transactions for companies within
    comparable sectors
  • We look closely at the specific characteristics
    of each transaction in order to find the most
    comparable multiples

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Multiple Analysis
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Discounted Cash Flow Analysis
  • A discounted cash flow approach offers a good
    proxy for value due to the following
  • Multiple analyses may be too weighted to the
    historical performance, which in some cases is
    limited
  • Discounted cash flow approach captures both
    growth and operating profitability

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Discounted Cash Flow Analysis
  • The discounted cash flow analysis captures the
    value of both the value of the existing balance
    sheet and the value of new business.

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Discounted Cash Flow Analysis
  • In valuing the existing balance sheet, we focus
    on the following components
  • The existing surplus (pro forma for any reserve
    strengthening or other adjustments)
  • The value of the runoff of the reserves
    (actuarially determined payout pattern)
  • Any value/equity in the unearned premium reserve
    (value of deferred acquisition cost)

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Discounted Cash Flow Analysis
  • In valuing the new business, we focus on the
    following factors
  • The premium growth potential
  • The potential to introduce new products
  • The projected combined ratio for the business
  • The expected payout of the future reserves and
    associated investment income

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Valuation Summary
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Non-traditional Approach
  • Due to the uncertainty of the quality of the
    Company's earnings, We value some of the
    Companies based on an analysis of the various
    components of the company

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Non-traditional Approach - Example
  • The Company stock has not recovered since its 2nd
    Quarter earnings announcement

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Non-traditional Approach
  • As a starting point we attempt to determine the
    tangible book value of the company
  • Eliminated the goodwill from previous
    transactions
  • Estimated the current adequacy of loss reserves

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Non-traditional Approach
  • We add to the current book value an estimate of
    the value of the premium using two approaches
  • Value based on projected cash flows from the
    in-force book of business
  • Estimated cost to purchase a book of business of
    that size

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Non-traditional Approach
  • We also attempt to assess the value of the runoff
    of the loss reserves by estimating the payout of
    the liabilities and the associated investment
    income earned on the runoff.

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Non-traditional Approach
  • The final component of value that we included was
    the value of any non-risk bearing segments
  • Value of service businesses are sometimes
    incorporated in the book value of the company
  • Estimated value from future earnings on the
    business or estimated sale value of the business

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Non-traditional Approach
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Non-traditional Approach
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Non-traditional Approach
  • The value of new business was projected out over
    30 years. The underwriting performance
    assumptions were as follows
  • Base Case
  • 118 combined ratio, decreasing to 117 in 2002
  • Loss ratio of 95
  • Expense ratio of 23

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Non-traditional Approach
  • Case 2
  • 115.7 combined ratio, decreasing to 114.7 in
    2002
  • Loss ratio of 95, decreasing to 94 in 2002
  • Expense ratio of 20.7

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Non-traditional Approach
  • Gross written premium is projected to decrease
    20 in 2000, increase at an annual rate of 5
    from 2001 to 2004, slow to a growth rate of 2.5
    from 2005 to 2009, and then grow at a rate of 1
    for each year thereafter
  • A valuation range was obtained by applying
    discount rates to both scenarios

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Non-traditional Approach
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Non-traditional Approach
  • An estimated valuation range was generated by
    selecting a discount rate of 7-10 and
    calculating the implied NPV.

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Non-traditional Approach
  • A valuation range was selected by applying
    current multiples of public companies and
    multiples from MA transactions to the projected
    results of the company

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Conclusion
  • Why are you doing the valuation?
  • For whom are you doing the valuation?
  • What changes may occur at the target or the
    investment?
  • Everybody has an opinion, thats what makes a
    market

Casualty Actuarial Society
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