Re/insurers ponder what to do with capital that is returning to the market “with a vengeance”

Capital has come back to the global re/insurance market “with a vengeance” in 2009, and the debate is on as to whether companies will try to reduce some of their capital through share buybacks or mergers and acquisitions activity in 2010, speakers told a Guy Carpenter seminar held in Toronto.
Whereas the recent volatility in the global markets erased almost 18% of the global re/insurance market’s capital between 2008 and 2009 (dropping it from $112 billion to $91 billion), that slide appears to have almost completely reversed.
In fact, the global property and casualty industry has more capital now than it had in 2007, said David Flandro, head of Guy Carpenter’s business intelligence unit. That 2007 level followed two years of relatively benign hurricane activity. 
But the return of the days of excess capital means the “outlook for 2010 is grim,” Flandro said. “What’s wrong with having capital?” he asked. “If an insurance company has a lot of capital, it becomes ever more difficult to service that capital, and then it becomes more difficult to earn ROE commensurate with investor expectations. People start to say: ‘Why am I going to buy insurance stock and take 10% ROE when I could buy [a different stock with a higher ROE]? That’s reasonable.”
In response, companies have at least two options to boost their ROE by reducing their capital (i.e. increasing the rate of return by reducing their equity). One is to use capital to buy back shares from shareholders, a phenomenon that Rich predicted will happen more frequently in 2010.
“I would say that a lot of [re/insurers] are at a point where they have excess capital, so I don’t think it’s an if [they will buy back shares], I think it will be a when,” Rich said.
“Some will want to buy back [shares] now. Some of them will wait until after the [2010] hurricane season. And if we have a big hurricane, we will know who is right.”
But opinion remains divided about the possibility of future M&A activity.
Rich doesn’t see a lot of M&A activity happening in 2010, because the price-to-book (value) ratio of most companies is low right now — a ratio of about one on average for the industry in North America.
“[Potential buyers] don’t really want to…buy another company using [their own] undervalued stock,” Rich said. “[Potential sellers] don’t want to sell under book value.”
But Flandro sees it another way. “The ratios [showing book value] are diverse,” he said. “As capital has flowed back into the industry, people are better capitalized now then the were at one time…Everybody looks pretty good right now. One of the things our clients are starting to worry about is: ‘Which of our counterparties is going to be around in three to five years?'”