Europe
A growing number of European insurers are announcing substantial
share buybacks, a trend sparked by a host of factors including
surplus capital built up in recent years, a shortage of suitable
expansion opportunities and shareholder activism. While the trend
does hold risks, they appear limited for now.
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There has been a spate of share buyback announcements by European
insurers in recent months, a trend that has caught the attention of
rating agency Moody’s Investor Services. The scale of the buybacks
is unprecedented in recent history, said Timour Boudkeev, a senior
credit officer at Moody’s.
Among major European insurers currently executing share buybacks
are ING Group, Munich Re Group, Swiss Re and Legal & General.
Axa recently completed a €600 million ($850 million) buyback.
There are a number of reasons insurers have become keen to return
capital to shareholders, explained Boudkeev. Among them is a
significant change in attitude towards achieving the highest
possible rating.
He explained that many European insurers once prided themselves on
having the highest possible rating (Aaa in the case of Moody’s), an
achievement perceived as a hallmark of financial strength and a key
competitive advantage. Maintaining this rating was regarded as a
core operating objective and in many cases meant limited
distributions to shareholders, resulting in very high, and often
ever-increasing, capitalisation levels.
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By GlobalDataFocus on peer group average rating
However, said Boudkeev, in the early years of this decade, when
turbulence in equity markets coincided with sizeable adverse
prior-year reserve development (primarily in insurers’ US
subsidiaries), top-tier European insurers and reinsurers lost their
Aaa ratings. “Significantly, none of them has since committed
themselves to regaining the Aaa rating level,” stressed Boudkeev.
Instead, insurers appear to be targeting a rating that is
consistent with peer group averages and does not generate negative
publicity, said Boudkeev.
Other factors are at play in the share buyback drive, including a
shortage of growth opportunities that has left many insurers with
few avenues to invest surplus capital.
Boudkeev noted that Western European markets are mature and highly
consolidated, whereas in emerging markets, although growth rates
are higher, “valuations appear increasingly questionable”. The
result was that, with few exceptions, European insurers’ appetite
for major acquisitions has remained relatively low in recent
years.
European insurers are also not immune to shareholder activism.
Boudkeev noted that entities such as hedge funds and private equity
firms are in a position to accumulate sizeable stakes in insurers
and pressure them to increase their commitment to shareholder value
creation. “There is an increasing perception in the industry that
if management does not deliver on shareholder value maximisation
quickly, someone else will step in and do it for them,” said
Boudkeev.
In the context of this urgency, he said, it was clear that one of
the quickest ways to increase return on equity in the absence of
credible growth plans is to increase distributions to shareholders,
by way of either higher dividend payouts, share buybacks or a
combination of the two.
Lowering risks
In addition, said Boudkeev, in recent years many large European
insurers have undertaken determined efforts to lower risks in their
balance sheets by reducing exposure to equities, unwinding
participations in associates and, in some cases, protecting life
insurance liabilities against a protracted period of low interest
rates. This, combined with strong earnings generation since 2003,
has helped them to restore their capital strength to levels not
seen since the late 1990s.
He continued that returning sizeable amounts of equity to
shareholders would normally be associated with higher levels of
financial leverage, which could put negative pressure on ratings.
However, he explained that share buybacks as they are currently
contemplated by most insurers may not result in substantial
increases in leverage.
One reason for this, said Boudkeev, is that most insurers do not
yet go beyond distributing more than 100 percent of their annual
net income and, therefore, in the absence of additional debt
issuance, their leverage would not increase. Another reason is an
emerging trend for insurers to replace maturing senior debt with
hybrid instruments. Hybrid instruments often have a high equity
content and in many cases result in effective financial leverage
declining despite large share buybacks.
Capital management models tell a similar story, said Boudkeev:
despite buybacks, capitalisation is stable or marginally
improving.
He pointed out that high earnings retention was also no guarantee
of superior financial strength. “In the past, managements have been
only too keen to use excess capital for aggressively growing their
market share by engaging in price wars or for making expensive
acquisitions,” said Boudkeev.
Aggressive growth strategies reinforced the insurance cycle and
contributed to poor reserve adequacy over time, he added.
Potential for positive effect
Indeed, stressed Boudkeev, returning capital to shareholders when
the pricing cycle is just beyond its peak is potentially positive.
Reducing surplus capital by way of buybacks will limit resources
available for expansion in an unfavourable market and may reinforce
the need to maintain rigour in underwriting decisions. “To the
extent that a meaningful number of leading players in the industry
do this, the insurance pricing cycle may lose some of its notorious
volatility,” said Boudkeev.
In addition, he added, a capital position that is fully adequate,
rather than excessive, may also have other benefits, particularly
in Europe, where insurers historically relied on investment income
as a key source of shareholder return. A high exposure to equities
is hard to justify when there is no slack in the capital structure
and to the extent that the asset class that is liquidated to return
capital to shareholders is equities, incremental risk to
policyholders and bondholders associated with such capital
management actions may actually be quite low.
Boudkeev concluded: “While there is some risk that some runners in
the race towards decapitalisation may become too excited, it
appears to be contained at this stage. As long as distributions do
not exceed 100 percent of net income, less any growth in required
capital, very few large groups are likely to experience serious
pressure on ratings, having built up substantial capital buffers in
recent years.”
