What makes stock sizzle? It's no secret some life insurance stocks have greater investor appeal than others. (Life/Health: Underwriting Insight).The capital markets have been characterized by unrelenting volatility in recent years, resulting in a drastic loss of value for many companies as investors reassess reassess Verb to reconsider the value or importance of reassessment n Verb 1. reassess - revise or renew one's assessment reevaluate their stock holdings. To determine how this market disarray has affected insurance company valuations, Ernst &Young examined the market performance of 69 U.S.-based, publicly traded companies publicly traded company A company whose shares of common stock are held by the public and are available for purchase by investors. The shares of publicly traded firms are bought and sold on the organized exchanges or in the over-the-counter market. engaged in underwriting life, health, annuity and property/casualty businesses, over a five-year period ending in early 2002. The research identified a set of performance measures that investors have used consistently to differentiate among insurance companies over the past five years-a period characterized by extreme capital-market swings, a large number of life company demutualizations, high levels of industry consolidation and a changed competitive landscape. Concentration is rewarded. The markets reward companies that exhibit higher degrees of concentration in either the life, annuity and health lines or the property/casualty sector. Conversely, companies that diversify across these two broad industry sectors are penalized pe·nal·ize tr.v. pe·nal·ized, pe·nal·iz·ing, pe·nal·iz·es 1. To subject to a penalty, especially for infringement of a law or official regulation. See Synonyms at punish. 2. . The implication is that the markets approve of the divestiture The breakup of AT&T. By federal court order, AT&T divested itself on January 1, 1984 of its 23 operating companies, which became known as the Regional Bell Operating Companies (RBOCs). trend that has occurred as conglomerates have sought to become more concentrated. For the multilines, the analysis found the valuation effect of lowered asset base and reduced earnings associated with divesting an entire line of business is likely to be substantially offset by the "valuation premium" gained from achieving greater business concentration. That is, market cap will likely fall in response to a major divestiture, but it probably will not fall by as much as may be indicated on a pro forma As a matter of form or for the sake of form. Used to describe accounting, financial, and other statements or conclusions based upon assumed or anticipated facts. The phrase pro forma basis that does not take investor preferences for company specialization into account. Similarly, recognition of the "concentration premium" should be factored into merger and acquisition considerations. Acquisitions of multiline targets may provide unrecognized value creation potential due to the possibility of subsequently divesting certain of the acquiree's business lines in order to increase the overall concentration level of the acquirer. Individual lines present a mixed bag. Investors' expectations of the value creation potential of the life/health lines have changed little over the past five years. In contrast, investors' expectations for the property/casualty lines have shifted as a result of the radically changed rate environment. Whereas the life business used to carry a considerably higher valuation multiple than the P/C business, by early 2002 the two lines had nearly converged, reflecting rapidly rising P/C rates as well as the ongoing commodification Commodification (or commoditization) is the transformation of what is normally a non-commodity into a commodity, or, in other words, to assign value. As the word commodity has distinct meanings in business and in Marxist theory, commodification and margin pressure facing life insurers. Investors have soured on the annuity business. Five years ago, high concentrations in both variable and fixed products contributed significantly to market valuations. By early 2002, however, this contribution had eroded completely, and incremental Additional or increased growth, bulk, quantity, number, or value; enlarged. Incremental cost is additional or increased cost of an item or service apart from its actual cost. growth in the annuity business was no longer rewarded with increases in valuations. This steady erosion, beginning in 1998 and continuing through the "bubble" economy of 1999 and 2000, indicates that investor perceptions of the annuity business are not solely a reaction to the current state of the stock market. Rather, investors have become increasingly skeptical about the industry's ability to extract value from a business that has become increasingly competitive and commodified. A market rebound may help restore value to the variable annuity Variable Annuity An insurance contract in which, at the end of the accumulation stage, the insurance company guarantees a minimum payment. The remaining income payments can vary depending on the performance of the managed portfolio. business, although the tough competitive landscape will limit the upside. Also, we doubt that the fixed-annuity, spread-based businesses will contribute much to value in the near term as margins come under pressure, especially when rates begin to rise. Return on equity remains the principal determinant of market multiples. Not surprisingly, the profit margin is the most important driver of the three components of ROE, followed by operating leverage Operating Leverage A measurement of the degree to which a firm or project relies on fixed rather than variable costs. Notes: The higher the degree of operating leverage, the greater the potential danger from forecasting risk. and financial leverage. Expense efficiencies are also important, as investors view expense levels as an indication of the competitiveness of specific product lines. The research found that demonstrating an ability to maintain a competitive cost structure is the best way to change investor expectations and be rewarded with a higher multiple higher multiple Obstetrics Multigestation ≥ triplets: quadruplets, quintuplets, sextuplets, septuplets, octuplets, etc tuplets . Overall, the analysis reinforced some conventional wisdom while shedding new light on how the markets value the contribution of particular business lines and business mix. The valuation of the life/health business has been much more stable over time than either the property/casualty or the annuity business. The research confirmed that specialized insurance companies are more highly valued than diversified companies diversified company A company engaged in varied business operations not directly related to one another. A diversified company is less likely to suffer either a collapse or a spectacular gain in earnings compared with a firm concentrating its operations in a , underscoring the value of a strategy that combines further consolidation with a drive toward achieving greater specialization. Robert W. Stein, a Best's Review columnist, is chairman of Global Financial Services The examples and perspective in this article or section may not represent a worldwide view of the subject. Please [ improve this article] or discuss the issue on the talk page. for Ernst & Young, New York New York, state, United States New York, Middle Atlantic state of the United States. It is bordered by Vermont, Massachusetts, Connecticut, and the Atlantic Ocean (E), New Jersey and Pennsylvania (S), Lakes Erie and Ontario and the Canadian province of . He can be reached at insight@bestreview.com. |
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