Managing Director & Partner
Here’s the good news: in the five years from 2015 through 2019, reinsurers delivered an average annual total shareholder return of 14.6%, outperforming the market by 5 percentage points and the full insurance sector by 6 percentage points. Here’s the catch: the outperformance was mainly thanks to cyclical recovery of price-to-book (P/B) multiples, which cannot be expected to continue. And indeed, since the pandemic struck at the start of 2020, reinsurance (and insurance) stocks have trailed the broader market by double-digit spreads, with multiples returning to 2010 levels.
The story is different for the few reinsurers in the top quartile. These companies delivered an average annual TSR of 20% since 2014 (54% in 2019). The returns were driven primarily by stronger tangible book value (TBV) growth of 9% as well as multiple expansion. In the long run, TBV growth has been by far the most important source of TSR in insurance, explaining 80% of top-quartile performance. In contrast, returning cash to shareholders has generally not led to outperformance.
BCG’s Smart Multiple analysis has found that return on equity (RoE) is the key driver of price-to-tangible book value multiples. High RoEs typically are the result of disciplined capital allocation to attractive underwriting risks. This is one place where companies can develop an edge (via scale or skill) while minimizing allocation to unrewarded asset risks (through a mismatch in assets and liabilities) and returning idle capital to shareholders.
The same analysis shows enormous gaps in RoE performance. Over the last five years, the top ten listed reinsurers delivered on average 8% RoE (2 percentage points below the sector average). After adjusting for about 1 percentage point of abnormal natural-catastrophe experience, the sector’s average RoE of some 9% barely covers cost of equity. Just two reinsurers clearly have exceeded their cost of equity and hence earned the right to grow. The others need to first improve returns through tighter business focus, improved capital allocation, and better cost efficiency.
In property and casualty (P&C) reinsurance, there is an enormous 13 percentage-point gap between top- and bottom-quartile return on tangible equity (RoTE) performance, mainly because of portfolio mix, capital allocation, and cost efficiency. In life and health (L&H) reinsurance, the gap between top and bottom is narrower: 7 percentage points. Both reinsurance segments operate at lower RoTEs than primary insurance companies and as a result, reinsurers are underrepresented in the top industry quartile in terms of growth in franchise value and TSR.
In 2020, in the wake of COVID-19, reinsurers have underperformed the market by 22% YTD, similar to their performance in the aftermath of the global financial crisis. The sector's asset leverage was exposed by all assets falling at the same time, and reinsurers will take a substantial share of the more than $40 billion of damages in nonlife lines caused by losses that were not well covered by event risk models. These losses have been exacerbated by the high degree of uncertainty in projecting the final bill, especially in liability lines where litigation has just started. The current circumstances are uncharted territory, but it is clear that reinsurers need to fundamentally and substantially improve technical and fee margins given the looming further erosion of investment spreads—typically accounting for 60% to 80% of profits—compared with the last decade.
One way for reinsurers to address current issues and make themselves more resilient in the future is to transform into “bionic” companies. Rather than pursuing a pipe dream of complete automation and digitization, reinsurers can exploit the combined potential of human creativity and expertise and the insight and processing power of technology. In a bionic operating model, technology enriches human capabilities rather than replacing them. Bionic embraces all aspects of reinsurance, transforming distribution, creating new business models, and enabling better-informed decisions on underwriting, portfolio steering, and claims. It does so by adapting processes and data flows to how people work, by generating insights based on advanced analytics, and by making recommendations for all kinds of decisions.
BCG’s Digital Accelerator Index has already suggested that digital leaders deliver higher growth at lower cost, leading to significantly higher TSR. In the postpandemic world, reinsurers need to digitalize all aspects of their value chains. The race has already started, but many companies are still at the starting gate.
Explore the reinsurance industry’s performance and the need for the companies to move quickly toward bionic operating models—harnessing the combined strength of humans and technology—in this slide show, “The Drivers of Value Creation in Reinsurance.”