Worshipping at the Altar of Shareholder Value
John J. Kollar
Insurance Services Office, Inc.
November 15, 2000
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to private clients in the U.K.: The investments and strategies discussed herein
may not be suitable for all investors, if you have any doubts you should consult
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exchanges may have an adverse effect on the value of investments.
Weston M. Hicks
• Managing Director @ J.P. Morgan Securities,
Inc.
– equity research of p/c, health, multiline
insurers
• Senior Research Analyst @ Sanford C.
•
Bernstein & Co, Inc.
Fixed income Securities @ Moody’s Investors
Service
• Commercial Banker @ Bank of America &
•
Chase
Auditor @ Peat, Marwick Mitchell & Co.
Weston M. Hicks (Cont’d)
• BS in Business & Economics from Lehigh
•
•
•
•
•
University
CFA, CPA
First place for last 7 years on Institutional
Investor’s All-American Research Team
Top P/C Analyst in 2000 by Reuters & the
Street.com
Member of New York Society of Security
Analysts
Past President of Association of Insurance
& Financial Analysts
David B. Kelso
• Executive Vice President & Chief Financial
Officer, @ The Chubb Corporation/Chubb &
Sons, Inc.
– applies broad corporate strategy to all financial
decisions and actions
• Member of Policy Committee - business
planning, resource allocation, corporate
finance, mergers & acquisitions, treasury, tax,
accounting, internal audit, IT, actuarial
David B. Kelso (Cont’d)
• CFO & Head of Retail Banking @ First
Commerce Corporation
• Partner and Head of North American Financial
Service Practice of Gemini Consulting
• Corporate Lending Officer @ Chemical Bank
• BA from Princeton University
• MBA from Darden School, University of
Virginia
Stephen P. Lowe
• Principal and Consulting Actuary @
Tillinghast - Towers Perrin
– manager of global product/
service development
– actuarial analyses
– strategic planning
– economic value measurement
– stochastic models to measure and
manage risk and capital
– exposure management
Stephen P. Lowe (Cont’d)
• Casualty and corporate actuarial
departments @ Aetna
• BS in mathematics from Union College
• FCAS
• Member of CAS Board
• Active in CAS & AAA
Shareholder Value
• Key components
• Property/casualty industry performance
– review
– outlook
Property/Casualty Industry - Some Other
considerations
• Cyclicality of results
• Regulation - solidity/solvency
• Mutuals/reciprocals
Convergence of Financial Services Industries
• Gramm-Leach-Bliley Financial Services
Reform Act
– removed legal barrier between insurers,
banks and securities firms
– regulation
Globalization
• Customers
• Insurers/reinsurers
• Free trade
Property/Casualty Risk Securitization
• General growth in derivative markets
• Catastrophe bonds/options
• Tokyo Disneyland catastrophe bonds sold
directly to financial markets
• NAIC securitization studies
Information Technology
Risk Assessment
• Catastrophe models
• DFA models
Business to Business (B2B)
• Communication
• Information
• Viruses
Marketing/Distribution
• Internet
Risk is Risk
• Enterprise Risk Management
• Capital management
“Worshipping At The Altar of Shareholder Value”
Weston M. Hicks
J.P. Morgan Securities
November 15, 2000
Overview
• Shareholder value - what is it, why is it
important?
• The scorecard: how is the propertycasualty industry doing
• Industry review and outlook
What is meant by “shareholder value?”
Shareholder value is the
long-term (3-5 year) growth
in the value of the
business
What shareholder value isn’t
Short-term earnings trends
Premium growth
Size of the company
Stature within the industry
Why shareholder value matters
• Shareholder value drives share
performance over time
• A rising share price allows a company
to attract & retain talent
• Opportunities may arise that require
low cost of capital
• Investors don’t have to invest in the
property-casualty industry!
Annualized Total Return (11/95-10/00)
30
20.98
20
11.48
10
0
S&P 500
S&P P&C
Annualized Total Return (11/95-10/00)
39.50
40
36.75
28.73
30
20.98
20
10
0
S&P 500
MMC
AIG
HIG
Annualized Total Return (11/95-10/00)
40
28.86
30
23.47
20.98
20
16.43
14.13
10
0
S&P 500
ACL
XL
SPC
CB
Annualized Total Return (11/95-10/00)
40
30
20.98
17.82
20
16.64
11.78
10
0
-3.83
-10
S&P 500
PGR
ALL
MCY
SAFC
Year-to-Date Appreciation
59.13
60
47.49
50
40
30
20
10
0
-10
-2.19
-20
S&P 500
S&P P&C
S&P Multiline
Property Casualty Insurance
Industry Trends
Long Term Trends In Capitalization
1980
1990
2000
Premiums
$94
$215
$300
Reserves
92
290
365
Surplus
52
136
330
($ billions)
Long Term Trends In Capitalization
1980
1990
2000
NPW/surplus
1.8x
1.6x
0.9x
Reserves/surplus
1.8x
2.1x
1.1x
Capacity utilization
95%
95%
50%
Excess Capital is in Both Personal
Lines and Commercial Lines
Personal
Commercial
Adj premium
113
183
Adj capital
112
160
Req'd capital
57
112
Excess
55
38
Industry Cash Flow is at a Bottom
30%
% Change Net Written Premium
25%
Cash Flow as a
Percentage of
Premiums
20%
15%
10%
5%
Year
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
1970
1968
1966
1964
0%
Paid to Incurred Ratios at All Time
Highs
50%
40%
35%
30%
25%
20%
15%
10%
5%
Industry
Personal Auto
Workers Comp
Comm'l Auto
General Liability
CMP
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
0%
1981
intial paid to incurred ratio
45%
Catastrophes are a Growth Market
$35.0
$30.0
Global Insured Catastrophe
Losses in Current Dollars
$25.0
$20.0
$15.0
$10.0
$5.0
Insured Catastrophe Losses
10 Yr. Average
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
1970
$0.0
Estimated ROI on 2000 Accident Year
Standard
Comm'l
Specialty
Comm'l
Personal
Auto
CR
120%
106%
104%
Investment
Return
7.5%
7.5%
7.5%
Leverage
1.5x
1.0x
2.0x
-0.2%
10.4%
5.4%
ROI
Summary
• Yesterday’s strategy of holding strong
capital position and waiting for “hard
market” unlikely to work
• Companies that have found profitable
growth opportunities have been the
value creators (AIG and HIG in
particular)
• Excess industry capital likely to cap
the upside in current cycle
“Worshipping at the Altar of Shareholder
Value
David B. Kelso
Chubb Corporation and Chubb & Son
November 15, 2000
In the areas of profitability and growth,
the P & C industry has shown mixed
results
Agency Companies
Direct Writers
1995 - 1999
90
18
Travelers
14
CHUBB
AIG
Hartford
GEICO
St. Paul
12
Allstate
10
Progressive
Safeco
8
6
CNA
GEICO
95
4
State Farm
USAA
2
Farmers
Combined Ratio (%)
Operating Ratio (%)
16
Progressive
Allstate
100
AIG
105
State Farm
110
CHUBB
Safeco
Farmers
Hartford
USAA
St. Paul
Travelers
CNA
115
0
-10
120
-5
0
5
10
15
20
NWP Growth (%)
Source: A.M. Best Company, company statements
* 12-quarter average, weighted by NPW, ending 12/31/99
25
-10
-5
0
5
10
NWP Growth (%)
15
20
25
Earnings growth is a major driver of
stock price
Value Migration in Insurance
(1999)*
AIG (5.03)
4.5
4.0
3.5
Citigroup
Value
Inflow
Danger
Point
3.0
Market Value
Book Value
Jefferson – Pilot
Cigna
2.5
Protective
2.0
Progressive
Lincoln
CHUBB
Travelers
1.5
Conseco
Torchmark
St. Paul
Stability
Frontier (-43%)
Enhance
Capital Re
Selective
Transatlantic
Safeco
1.0
0.5
Value
Outflow
0.0
50%
40%
High Growth
30%
20%
Net Income Growth
(1990-1999 CAGR)
10%
UNUM (-48%)
CNA (-50%)
Fremont (-61%)
Trenwick (-32%)
0%
-10%
Low Growth
*1999 data used unless otherwise noted; Capital Re net income growth is 1990-1998 and MV/BV is based on 1998 figures. Net Income growth for Travelers
and Fremont are from 1995 to 1999.
Source: Compustat, Mercer analysis, Marketwatch.
Earnings stability is another, ...
Volatility of Earnings
EPS Growth Rates
5Y
3Y
2Y
CV* of Growth Rates
5Y
3Y
2Y
Market - To - Book
1994
1996
1999
AIG
15.0%
13.8%
12.9%
0.15
0.15
0.15
1.5-2.0
1.8-2.5
3.4-4.9
XL
16.2%
14.1%
7.3%
0.62
0.90
0.90
1.1-1.5
1.2-1.7
0.9-1.8
Travelers 17.4%
17.4%
10.4%
0.70
0.70
0.22
N/A
1.4-2.3
1.0-1.7
CNA
380.4% 575.3% 871.0%
2.16
1.90
1.57
0.8-1.2
0.8-1.1
0.6-1.0
ACE
-114.4%
1.0%
-6.8%
(2.38)
23.62
(3.95)
0.9-1.4
0.9-1.6
0.7-1.8
CHUBB
4.8%
-1.8%
-8.8%
3.09
(7.10)
(0.49)
1.4-1.7 1.3-1.9
1.2-2.2
Safeco
-6.9%
-21.3%
-32.0%
(3.55)
(0.90)
(0.23) 1.0-1.4
St Paul
9.5%
17.7%
9.7%
4.41
3.16
*CV is the coefficient of variation for EPS growth rates.
7.87
0.9-1.3
0.6-1.2
1.1-1.5 1.0-1.3
0.8-1.3
. . . And return - on - equity is a third
Financial Services Value Map
(1999)*
Reinventors
Capital One (6.27)
American Express (7.37) Schwab (13.8)
6.0
T. Rowe Price
First Data
AIG
5.0
State Street
4.0
Citigroup
Market Value
Innovative
Business Designs
AFLAC
Book Value
Wells Fargo
3.0
Cigna
Under Performers
2.0
Frontier (-8.36)
UNUMProvident
1.0
Fremont
Trenwick
-1.0
-0.5
0.0
0.0
CNA
Jefferson – Pilot
Protective
United Healthcare
Progressive
First Union
Lincoln
Torchmark B of A
CHUBB
Travelers
Conseco
Capital Re
St. Paul
Allstate
Enhance
Countrywide
Safeco Selective
Transatlantic
0.5
1.0
1.5
2.0
Chase Manhattan
Companies
with Potential
Unrecognized
Value
2.5
3.0
3.5
Return Over Cost of
Capital
(ROE/Ke)
*1999 data used unless otherwise noted; Capital Re ROE is based on 1998 data. Frontier’s stock price hit a new 52 week low on 4/17/00.
Note: The S&P cost of capital of 10% was used for all companies.
Source: Compustat, Mercer analysis, Marketwatch.
Growth alone does not create superior
performance . . .
Implied Market-to-Book Ratio
E.P.S. Growth Rate
11%
0%
1.0
2%
1.0
4%
1.0
6%
1.0
8%
.9
10%
.9
12%
.8
13%
1.2
1.1
1.2
1.2
1.2
1.4
1.4
15%
1.2
1.3
1.3
1.4
1.6
1.8
2.0
17%
1.4
1.4
1.5
1.7
1.9
2.2
2.4
19%
1.5
1.6
1.7
1.9
2.2
2.7
3.1
R.O.E.
Source: Benjamin Branch and Bradley Gale, “Linking Corporate Stock Price Performance to Strategy
Formulation”; this study analyzed the drivers of market-to-book of 600 companies over 14 years.
. . . Particularly in an excessively
overcapitalized industry
U.S. P&C Industry is Overcapitalized by Approximately 20-34%
Economic Capital vs. Available Capital
$500BN
$422 BN
$400
$353 BN
$315 BN
$300
$200
$100
$0
Economic Capital
at "A” S&P
Solvency Standard
Economical Capital
at "AA” S&P
Solvency Standard
Available Capital
© 2000 Oliver, Wyman & Company, eRisks, and Risk Management Solutions, Inc.
Note: Moody’s estimates, however, that the industry’s shortfall in reserves total $261 million, or 4.2%.
Worshipping at the
Altar of Shareholder Value
Stephen P. Lowe
Tillinghast - Towers Perrin
November 15, 2000
I will be covering three topics...
1
Viewpoint on shareholder value
2
Why
focus on shareholder value?
3
Trends in the use of shareholder value
measurement
1
Shareholder value is a measure
of the total value of an enterprise to
Actual
Proxy
its
owners
shareholder value
shareholder value
= Current equity
+ Present value of
future free cash
flows -distributable
profits
1
Key characteristics of a
PV-FCF
proxy
measure
of
shareholder
FUTURE
DISCOUNT
CAPITAL
EXPERIENCE
RATE
value
Future
cashflows
projected
using “best
estimate”
assumptions
Projections
allow for
regulatory &
working
capital
requirements
Present
values
determined
using a
market-based
risk discount
rate
PV-FCF VALUE MEASURE
1
Actual shareholder value and
proxy PC-FCF value can be related
External
Market
Market Value
• Observable
in capital
market
• Risk (b)
estimable
Internal
Economic
Embedded
Value
• Existing
customers
• Measured
using
validated
assumptions
2
No conventional financial
performance
Percentage
of Enterprise
Valueshareholder
Explained
indicator
explains
value very well
35
30
25
%
20
15
10
5
0
Sales
EPS Cash flow EVA
growth growth growth
ROE
Source: Seabury analysis 10/98
Sample data include all insurance (Life and General) companies analysed by Valueline
2
Value-based performance is critical
when
the
business
involves
an
up-front
• In property/casualty
investment
– New business expense is higher than
renewal
– Loss ratiosNew
improve
asInitially
business
“seasons”
Business is
Unprofitable
– Retention rates are key to value creation
Alignment of the interests of
management with the interests of
shareholders
Behavioral
Implications of
2
Measures
ROE
EVA
EARNINGS
• Grow
• Improve ROE without
• Focus only on regard to
•
highest ROE
product line
Forego growth•
that lowers
average ROE
capital
required
No credit
for balance
sheet
manageme
nt
• Grow
earnings
and
minimize
capital
-- forego
growth
-- milk
assets
• Ignore
dividends
TOTAL
SHAREHOLDE
R RETURN
• Understand
risk, return
and growth
• Responsible
for managing
all factors
• Most useful
for target
setting and
benchmarks
3
Current state of play
Funds
Management
Life
Insurance
P/C
Insurance



Publication in accounts/
analyst compendiums



Internal management



M&A activities
“The Times They Are A - Changin’ ”
- Bob Dylan