While property/casualty insurance stock valuation levels are finally exceeding book values after four years of below-book levels, a near-term return to higher historical valuation levels is unlikely, according to a new analysis by Conning.
“Yes, underwriting fundamentals have improved, supporting higher valuations, however the build-up of capital and depressed interest rates act as dampers on further improvement,” said Steve Webersen, director of research at Conning, in a statement about the study, “Property-Casualty Valuations: Have Valuations Reached a New Equilibrium?”
“Currently, the pendulum has swung to the ‘more capital is better’ side at the expense of returns and ultimately valuations. Until this situation is resolved, the excess capital position will likely act as a ceiling on valuations,” Webersen said.
Current valuations at roughly 10 percent of GAAP equity for publicly traded companies, Conning says, noting that other valuation methods, such as economic value (market value of assets in excess of the present value of liability plus estimated reserve adequacy on a statutory basis for the entire industry) and discounted cash flow analysis (the present value of dividends and a terminal surplus value for stock companies on a statutory basis) result in similar valuation multiples.
Noting that value multiples exceeding 1.00 had not been seen in the industry since early 2009, the report says that the recovery to levels a bit above 1.00 is a function of both the overall equity market and also sustained insurance price increases seen since late 2011.
Still, the valuation heights of the late 1990s—greater than twice book value—will remain a distant memory, Conning says. In fact, the report says that Conning analysts are not even convinced that the industry can support a return to long-term valuations in the range of 1.3- to 1.4-times book value.
“While there are some companies that are valued well above the industry averages (and others well below), as a group the property/casualty universe of publicly traded companies is trading at only a modest premium to book value”—and the lower valuation levels may represent a new normal, Conning says.
Long-term factors at work to keep a lid on valuations include: reduced leverage, shorter recovery phases in the underwriting cycle, and low interest rates.
Commenting on the low leverage factor—increased capital against premiums and invested assets— Conning says the “prevailing theme from the regulatory and rating agency front is that more capital is better,” adding that uncertainties of Solvency II implementation and state versus federal regulation suggest this trend is likely to continue.
The Conning report includes a sector analysis—showing, for example that personal lines insurers have higher valuations owing to higher returns and lower volatility than other sectors—and an analysis of P/C industry valuations to other financial services firms.
“The financial crisis had a negative impact on the property/casualty industry, but also resulted in narrowing the valuation gap relative to other financial sectors,” Conning reports, noting that the S&P bank index valuation declined from over 3.0-times book value to 1.5-times in 2012, putting valuations more closely in line with the S&P property/casualty index.
“Looking at the impact a different way, the market capitalization of the property/casualty index increased over 50 percent from 2007 to 2012, while the bank index saw a decline of over 20 percent.”
Source: Conning Research