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How Investment Bankers Value Insurance Companies
Valuation of Insurance Operations
April 10
Casualty Actuarial Society
In Today’s Market
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Two Approaches Market Approach Fundamental Approach
Traditional Approach Non-traditional Approach
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Market Approach Research Analyst Buy-side Analyst Investor Community
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Market Approach Valuations for property casualty insurance
companies have declined significantly during the past year
The decline in the property casualty sector is the result of deterioration in the industry fundamentals that drive value
Historical Relative Performance
50%
60%
70%
80%
90%
100%
110%
120%
03/31/1999 05/31/1999 07/31/1999 09/30/1999 11/30/1999 01/31/2000 03/31/2000
Per
cent
age
of B
ase
Pri
ce
S&P 500 S&P P&C
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Market Approach Volatility of the industry’s results has declined
over the last twenty years
0.0x0.5x1.0x1.5x
2.0x
2.5x3.0x
3.5x4.0x
Standard Deviation
1942-46
1947-51
1952-56
1957-61
1962-66
1967-71
1972-76
1977-81
1982-86
1987-91
1992-96
Volatility of Property & Casualty Earnings
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Which operating factors drive stock market values? Profitability, as measured by return on
equity Profit margin Operating leverage
Earnings consistency Standard deviation of change in earnings Reserve development
In other words, the market rewards risk adjusted returns on capital
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Value Drivers
Return on Equity
Earnings Consistency
Earnings Growth
Price/BookBaldwin & Lyons, Inc. 0.79xW.R. Berkley Corporation 0.65Capitol Transamerica Corp. 1.00HCC Insurance Holdings, Inc.
1.31
Markel Corporation 1.74Medical Assurance, Inc. 1.40NYMAGIC, Inc. 0.52Penn-America Group, Inc. 0.78Philadelphia Cons. Holding Co.
1.13
RLI Corp. 0.93
Company Market Cap
($ in millions)
1999 ROE
Baldwin & Lyons, Inc. $226.1 6.5% W.R. Berkley Corporation 384.3 -5.5 Capitol Transamerica Corp. 133.1 12.1 HCC Insurance Holdings 610.5 15.9 Markel Corporation 667.6 9.9 Medical Assurance, Inc. 456.3 14.4 NYMAGIC, Inc. 121.1 7.1 Penn-American Group, Inc. 63.0 2.3 Philadelphia Cons. Holding Co. 181.8 10.4 RLI Corp. 272.9 10.6
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Value Drivers
MAI
HCC
MKL
CATA
RLIPNG
PHLY
NYM
BWINB
R2 = 0.3554
0.00
0.25
0.50
0.75
1.00
1.25
1.50
1.75
2.00
2.0% 5.0% 8.0% 11.0% 14.0% 17.0%
ROE
Pri
ce/B
ook
(x)
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Value Drivers
CurrentP/E 1996-1998 1996-1999 1996-1998 1996-1999 1996-1998 1996-1999
Baldwin & Lyons, Inc. 12.7 x 8.3% 5.6% -11.7% -5.0% 3.7% 3.4%W.R. Berkley Corporation NM 14.1% 13.0% -22.8% N/A 7.1% -2.8%Capitol Transamerica Corporation 8.3 7.0% 2.3% 2.9% -3.1% 9.5% 4.0%HCC Insurance Holdings, Inc. 13.4 -9.7% -6.9% 37.0% -13.3% 16.5% 11.4%Markel Corporation 16.6 4.1% 12.5% 10.8% -4.5% 25.2% 11.7%Medical Assurance, Inc. 10.0 16.3% 16.3% 23.4% 14.5% 16.2% 12.3%NYMAGIC, Inc. 8.0 -11.5% -16.7% -9.5% -10.1% 12.5% 8.6%Penn-America Group, Inc. 37.3 13.8% 7.4% 12.7% -33.7% 59.1% 33.2%Philadelphia Consolidated Holding Corp. 12.0 30.5% 31.8% 22.4% 12.1% 26.1% 21.8%RLI Corp. 9.0 4.4% 14.3% 4.8% 7.0% 17.5% 13.2%
Mean 14.1 x 7.7% 8.0% 7.0% -4.0% 19.3% 11.7%Median 12.0 7.7% 9.9% 7.8% -4.5% 16.3% 11.6%
Premium Growth Rate Net Income Growth Rate BV/Share Growth Rate
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Value Drivers
YE 1996 YE 1997 YE 1998 YE 1999 % Change P/EP/E P/E P/E P/E 1998-1999
Baldwin & Lyons, Inc. 12.4 x 13.8 x 20.3 x 16.0 x -21.0%W.R. Berkley Corporation 13.4 14.5 19.4 N/M N/MCapitol Transamerica Corporation 12.7 15.8 10.9 6.8 -37.4%HCC Insurance Holdings, Inc. 27.6 19.9 11.8 25.9 118.7%Markel Corporation 10.8 17.5 17.8 21.5 21.0%Medical Assurance, Inc. 10.1 15.5 16.5 10.3 -37.2%NYMAGIC, Inc. 8.4 10.3 10.9 7.8 -28.2%Penn-America Group, Inc. 15.6 17.5 10.1 32.3 220.7%Philadelphia Consolidated Holding Corp. 12.4 15.7 16.9 11.6 -31.3%RLI Corp. 11.7 15.0 12.5 11.0 -12.0%
Mean 13.5 15.5 14.7 15.9 21.5%Median 12.4 15.6 14.5 11.6 -21.0%
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Who Cares about the Actuaries
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Frontier Chart
Frontier Stock History
$0
$5
$10
$15
$20
$25
$30
$35
$40
01/02/1997 07/02/1997 01/02/1998 07/02/1998 01/02/1999 07/02/1999 01/02/2000
Reserve Adjustmentof $40 Million
Reserve Adjustmentof $136 Million
Reserve Adjustmentof $150 Million
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Meadowbrook Chart
Meadowbrook Stock History
$0
$5
$10
$15
$20
$25
$30
$35
$40
01/02/1997 07/02/1997 01/02/1998 07/02/1998 01/02/1999 07/02/1999 01/02/2000
Reserve Adjustmentof $4 Million
Reserve Adjustmentof $2.7 Million
Reserve Adjustmentof $7.3 Million
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Consolidation and the Need for Economies of Scale
Opportunities for convergence Need for multiple distribution channels Need for broader line of products Need to achieve greater efficiencies Need to minimize rating pressures Need for improved access to capital
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Increased Consumer Awareness Consumers more informed through
internet More product choices and distribution
methods increase awareness Privacy issues becoming more
significant Consumers becoming informed about
structural alternatives (such as demutualization)
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Margin Erosion Commodity products (e.g. term
insurance, auto) New entrants Widespread consumer information Competitive pressures – increasing
loss ratios High cost distribution systems
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Rating Pressures and Capital Requirements Eroding profits or growth rates put
pressure on ratings Low rates of return on equity Some companies have high loss
ratios – reserves need strengthening
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Fundamental Analysis We traditionally base our valuation
of insurance companies on four valuation methodologies: Analysis of public market comparables Private and public market M&A
transactions Discounted cash flow analysis Additional areas of value that must be
developed with potential buyers
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Comparable Company Analysis We focus our multiple analysis on
Price/Earnings and Price/Book multiples. In analyzing these multiples, we consider the following factors: Core earnings power of the Company Earnings growth compared to the
comparable companies Relationship between price to book
value and return on equity
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M&A Transactions Analysis Additionally, we analyze recent
private and public market transactions for companies within comparable sectors
We look closely at the specific characteristics of each transaction in order to find the most comparable multiples
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Multiple AnalysisMultiple Valuation
(Dollars in thousands) Selected MultiplesLow High
Net Income ValuationAdjusted 1999 Net Income $1,935 $1,935Selected Multiple (1) 12.0 x 14.0 x
Implied Value $23,224 $27,095
Projected 2000 Net Income $1,766 $1,766Selected Multiple (1) 10.0 x 12.0 x
Implied Value $17,664 $21,197
Book Value ValuationCurrent Book Value $16,274 $16,274Selected Multiple (1) 1.00 x 1.25 x
Implied Value $16,274 $20,342
Required Book Value (4) $7,233 $7,233Selected Multiple (1) 1.25 x 1.50 x
Implied Value 9,041 10,849
Excess Book Value 9,041 9,041Selected Multiple 1.00 x 1.00 x
Implied Value 9,041 9,041
Total Implied Value $18,082 $19,890Casualty Actuarial Society
Discounted Cash Flow Analysis A discounted cash flow approach
offers a good proxy for value due to the following: Multiple analyses may be too weighted
to the historical performance, which in some cases is limited
Discounted cash flow approach captures both growth and operating profitability
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Discounted Cash Flow Analysis The discounted cash flow analysis
captures the value of both the value of the existing balance sheet and the value of new business.
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Discounted Cash Flow Analysis In valuing the existing balance sheet,
we focus on the following components: The existing surplus (pro forma for any
reserve strengthening or other adjustments)
The value of the runoff of the reserves (actuarially determined payout pattern)
Any value/equity in the unearned premium reserve (value of deferred acquisition cost)
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Discounted Cash Flow Analysis In valuing the new business, we focus
on the following factors: The premium growth potential The potential to introduce new products The projected combined ratio for the
business The expected payout of the future
reserves and associated investment income
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Valuation Summary
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DCF Valuation
Discount 1.75 x 11.0 xRate Book Value Net Income Average
13.0% $44,886 $45,832 $45,359
14.0% 42,957 43,862 43,40915.0% 41,126 41,992 41,559
16.0% 39,388 40,218 39,803
17.0% 37,738 38,533 38,135
Low HighSelected Valuation Range $40,000 $45,000
Terminal Multiples
Non-traditional Approach Due to the uncertainty of the
quality of the Company's earnings, We value some of the Companies based on an analysis of the various components of the company
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Non-traditional Approach - Example The Company stock has not
recovered since its 2nd Quarter earnings announcement
One-Year Stock Price History
$10.00
$20.00
$30.00
$40.00
$50.00
$60.00
03/31/1999 05/31/1999 07/31/1999 09/30/1999 11/30/1999 01/31/2000 03/31/2000
Sh
are
Pri
ce
50% drop after second quarter earnings showed significant reserve redundancies were used to manufacture earnings.
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Non-traditional Approach As a starting point we attempt to
determine the tangible book value of the company: Eliminated the goodwill from previous
transactions Estimated the current adequacy of
loss reserves
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Non-traditional Approach We add to the current book value
an estimate of the value of the premium using two approaches: Value based on projected cash flows
from the in-force book of business Estimated cost to purchase a book of
business of that size
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Non-traditional Approach We also attempt to assess the
value of the runoff of the loss reserves by estimating the payout of the liabilities and the associated investment income earned on the runoff.
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Non-traditional Approach The final component of value that we
included was the value of any non-risk bearing segments
Value of service businesses are sometimes incorporated in the book value of the company
Estimated value from future earnings on the business or estimated sale value of the business
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Non-traditional Approach
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9/30/99 Book Value $166,826Goodwill (76,604)
Tangible Book Value $90,222
Low HighOther AdjustmentsTangible Book Value 90,222 90,222Reserve Adjustment (26,000) (13,000)
Adjusted Book Value 64,222 77,222
Low HighValuation SummaryAdjusted Book Value $64,222 $77,222Estimated Value of Premium 27,000 37,000Estimated Value of Reserve Run-off 25,000 27,000Estimated Value of TPA & Service Segment 35,000 40,000Transaction Costs (2,500) (1,500)
Total Valuation $148,722 $179,722
Value per Share $15.33 $18.53
Current Price $18.13 $18.13Premium to Current Price -15.4% 2.2%
Non-traditional Approach
Paid Losses as a % of Initial Reserves
0%
10%
20%
30%
40%
50%
60%
70%
80%
1 2 3 4 5 6 7 8 9 10
Accident Year
Prior
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
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Non-traditional Approach The value of new business was
projected out over 30 years. The underwriting performance assumptions were as follows: Base Case:
118% combined ratio, decreasing to 117% in 2002
Loss ratio of 95% Expense ratio of 23%
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Non-traditional Approach Case 2:
115.7% combined ratio, decreasing to 114.7% in 2002
Loss ratio of 95%, decreasing to 94% in 2002
Expense ratio of 20.7%
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Non-traditional Approach Gross written premium is projected to
decrease 20% in 2000, increase at an annual rate of 5% from 2001 to 2004, slow to a growth rate of 2.5% from 2005 to 2009, and then grow at a rate of 1% for each year thereafter
A valuation range was obtained by applying discount rates to both scenarios
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Non-traditional Approach
DCF Valuation - New Business($ in thousands)
DiscountRate Base Case Case 2
10% $42,758 $52,07011% 36,890 44,90212% 32,003 38,94313% 27,909 33,95914% 24,460 29,76715% 21,539 26,219
High $37,000Low 27,000
Selected Valuation Range
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Non-traditional Approach An estimated valuation range was generated by
selecting a discount rate of 7-10% and calculating the implied NPV.
High $27,000Low 25,000
Selected Valuation Range
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(Dollars in thousands)Year
1 2 3 4 5 6 7 8 9 10
Assumed Payout Pattern 30.0% 22.5% 15.0% 10.0% 5.0% 5.0% 5.0% 2.5% 2.5% 2.5%
Loss Reserves OutstandingBeginning of Year $266,012 $186,209 $126,356 $86,454 $59,853 $46,552 $33,252 $19,951 $13,301 $6,650Loss Reserves Paid (79,804) (59,853) (39,902) (26,601) (13,301) (13,301) (13,301) (6,650) (6,650) (6,650)
End of Year 186,209 126,356 86,454 59,853 46,552 33,252 19,951 13,301 6,650 0
Average Reserves O/S 226,111 156,282 106,405 73,153 53,202 39,902 26,601 16,626 9,975 3,325Net Investment Yield 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0%
Net Investment Income 15,828 10,940 7,448 5,121 3,724 2,793 1,862 1,164 698 233
Net Investment Income 15,828 10,940 7,448 5,121 3,724 2,793 1,862 1,164 698 233Assumed Tax Rate 35.0% 35.0% 35.0% 35.0% 35.0% 35.0% 35.0% 35.0% 35.0% 35.0%
After-Tax Income $10,288 $7,111 $4,841 $3,328 $2,421 $1,816 $1,210 $756 $454 $151
NPV CalculationImplied
Discount Rate Value
6.0% $27,4577.0% 26,7718.0% 26,1169.0% 25,491
10.0% 24,89311.0% 24,322
Non-traditional Approach A valuation range was selected by applying current
multiples of public companies and multiples from M&A transactions to the projected results of the company
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($ in thousands)Selected MultiplesLow High
1999 Projected Revenue $31,128 $31,128Selected Multiple (1) 1.00 x 1.25 x
Implied Value $31,128 $38,910
1999 Projected Net Income $3,174 $3,174Selected Multiple (1) 11.00 x 13.00 x
Implied Value $34,913 $41,260
Selected Value $35,000 $40,000
Notes:(1) Based on the public market trading multiples for selected comparable companies.
Conclusion Why are you doing the valuation? For whom are you doing the
valuation? What changes may occur at the
target or the investment? Everybody has an opinion, that’s
what makes a market
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