Beyond share buybacks
Insurers have emerged from the financial crisis with stronger balance sheets and risk-based capital (RBC) ratios near 325 percent on average, compared with about 250 percent pre-crisis.1
But insurers now face a new challenge: the persistent low yield environment, combined with the short duration of P&C portfolios, is putting pressure on the investment income contribution to earnings. This, in turn, is affecting return on equity (ROE) and, potentially, share price performance. Despite a challenging 2011 for P&C liabilities, accumulated earnings and improved 2012 pricing and claims activity have resulted in greater levels of shareholder equity and stronger capital ratios.
Insurance company management teams assess how to deploy capital most efficiently. They may seek organic growth, acquisitions, capital-intensive investment strategies, or they may return capital to shareholders via share buybacks.
Recently, P&C insurers have actively repurchased shares with discretionary capital, reflecting the somewhat depressed price-to-book ratios and low investment yields.2 For example, share buyback activity throughout 2012 may represent about 5 percent of shareholder equity and about 2 percent of invested assets.3
Below, we present a case study of an illustrative P&C insurer managing capital according to the National Association of Insurance Commissioners (NAIC) RBC regime. We fi nd that utilising capital to back a multi-asset class investment strategy can achieve the same or higher short-term boost to ROE as a share buyback, while also offering the potential for strong return on capital.
An investment strategy may be considerably larger than a share buyback for the same amount of committed capital, a concept we call the investmentto- capital ‘leverage’ effect.4 We define this as the ratio of investment size to the capital required to back it. The primary source of this ‘leverage’ is the diversification within capital measures. The findings of this approach, that an investment strategy may be more accretive to ROE than share buybacks, apply globally across different regulatory regimes and insurer types.
Evaluating capital strategies
