Should North American life insurers stop prioritizing share buybacks?

The Realm of Growth in Life Insurance

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Nevertheless, companies that opt for reinvestment in growth initiatives and engage in mergers and acquisitions might find themselves in a more advantageous long-term position.

March 2, 2023 – Amongst life insurance entities in the United States, the inclination towards share buybacks remains a favored avenue for enhancing Total Shareholder Return (TSR). Remarkably, equity analysts seem to display a fondness for buybacks. During the first half of 2022, in the context of conference calls convened to dissect quarterly earnings outcomes, the terms "buyback," "repurchase," or "capital management" echoed more than 300 times in total across the top 20 life insurers in Canada and the United States, as determined by market capitalization.

Our analysis, however, posits that buybacks do not wield substantial influence on the long-term trajectory of share prices in the life insurance sector. Astonishingly, of the foremost 20 North American life insurers, 18 partook in buyback endeavors during the initial two quarters of 2022, amassing a staggering $14 billion – a sum equivalent to the entire market capitalization of a top-ten life insurer.

In this blog entry, we delve into the salient findings of our recent research concerning the preeminent capital allocation strategy within the industry thus far. Furthermore, we explore alternative approaches beyond the realm of buybacks that have the potential to usher in superior performance in terms of share value.

Overdependence on Buybacks by Insurers

When Wall Street inquires about the "capital return as a percentage of free cash flow or earnings" in the context of life insurers, what truly captures their attention is the velocity of share buybacks. According to our in-depth scrutiny, publicly traded life insurers in Canada and the United States have funneled approximately $275 billion back to shareholders over the past decade. This distribution of capital involved a blend of $190 billion allocated to share buybacks and $85 billion dispensed as dividends.

The deployment of buybacks has been widespread. 

Over the past ten years, as per our analysis, 17 of the premier 20 publicly traded life insurers in North America allocated the equivalent of at least 50 percent of their market capitalization solely to shareholders via buybacks. The allure of buybacks is conspicuous, yet it is often misconceived:

Elevated Share Prices: A reduction in outstanding shares culminates in an augmented earnings per share. Assuming a constant Price/Earnings (P/E) ratio, this translates to an escalation in share prices. However, this viewpoint overlooks the value of cash disbursed as part of the buyback and its ramifications on valuations and P/E ratios. Moreover, this outcome does not factor in strategic decision-making by the management team regarding corporate projects, nor does it signify the creation of intrinsic value.

Signaling to the Market: Analysts and investors have been conditioned over the years to believe that life insurers are better served by channeling excess capital back to shareholders, as opposed to investing it in the business. This is primarily because many of these companies have struggled to consistently generate returns surpassing the cost of capital.

Fostering Investor Confidence: Buybacks can serve as a signal that the management team harbors the belief that the insurer possesses deployable surplus capital. This can significantly bolster investor confidence, especially among those who harbor reservations regarding an insurer's reserves and capital sufficiency.

It is crucial to recognize that buybacks, in and of themselves, do not generate added value. They essentially amount to a financial transaction that transfers cash from the balance sheet to shareholders, similar to a common shareholder dividend. While shareholders who refrain from selling will find themselves in possession of a larger stake in the company's equity, the life insurer itself contracts in size, and the value of investors' holdings remains unaltered.

Life insurers that place a disproportionate emphasis on share buybacks may inadvertently adopt an overly defensive posture, a stance that research on corporate resilience has found to yield median company performance. On the contrary, strategies centered solely on offense entail a mix of sporadic triumphs and occasional catastrophic failures. True leadership and success come from being ambidextrous – displaying prudence in mitigating risks while zealously pursuing opportunities.

Moreover, it is worth noting that several life insurers that have strategically re positioned their business portfolios tend to generate enhanced free cash flow. However, a substantial chunk of their buybacks has been funded through one-time events such as divestitures and reinsurance transactions. Consequently, these companies may encounter mounting tension between sustaining historical levels of capital return and steering investments toward growth initiatives. Once a company embarks on the buyback path, extricating itself can prove to be a formidable challenge.

A More Effective Approach: Concentrating on Capital Intensity

Our analysis has unearthed only a marginal positive correlation between life insurers' share buybacks as a percentage of market capitalization and the annualized Total Shareholder Return (TSR) over the past decade, encompassing the majority of the most recent life insurer Initial Public Offerings (IPOs). Furthermore, our examination has identified an even weaker correlation in the past two years between the pace of share buybacks and TSR. This implies that the route to bolstering long-term TSR for life insurers will not primarily hinge on maximizing share repurchases. (It is noteworthy that the absence of a long-term correlation between TSR and share repurchase intensity extends beyond the life insurance sector as well.)

Instead, our analysis underscores the notion that a life insurer's business composition – delineated by its level of capital intensity in relation to earnings contribution – exerts a more discernible influence on long-term share price performance. Specifically, our regression analysis has unveiled an R2 value of 5 percent, signifying a weak correlation between buybacks and TSR.

A capital-light strategy typically revolves around products that entail minimal or no guarantees, encompassing areas such as employee benefits, protection-oriented life insurance, retirement services, and wealth and asset management. Conversely, a capital-intensive strategy places a greater emphasis on products such as universal life, variable annuities with living benefits, or legacy products endowed with robust guarantees. Broadly speaking, our research has indicated that capital-light life insurers tend to outperform the implied share price performance associated with their pace of share buybacks. In contrast, despite several capital-intensive carriers having repurchased shares equivalent to more than 100 percent of their market capitalization over the past decade, life carriers pursuing a capital-intensive strategy generally deliver subpar share price performance.

Several leading life insurers have charted a transformative course for their businesses by divesting from capital-intensive segments and reallocating capital, hitherto supporting these units, into capital-light domains characterized by appealing profit margins and Return on Equity (ROE) profiles. These strategic shifts have garnered recognition from investors, translating into superior TSR as well as an expansion in price-to-book valuation multiples It is worth noting that these insurers have also generated surplus capital, which they have subsequently distributed to shareholders through dividends and buybacks. However, it is abundantly clear that the transformation in strategy, and not the buybacks per se, has been the chief driver of their improved positions.

While returning capital to shareholders remains a predominant capital deployment strategy, it need not be the sole approach. In reality, share buybacks typically represent the least value-enhancing route that insurers can undertake with surplus capital. Intuitively, reinvesting in the business fosters organic growth by allocating capital to ventures that create value. Insurers have also registered successes by judiciously deploying capital in systematic mergers and acquisitions that align with their strategic priorities. These strategies can position an insurer to generate returns on equity that surpass their cost of capital, concurrently propelling top-line growth. The ability to generate such returns, as highlighted in our colleagues' insights in the Global Insurance Report 2023: Reimagining life insurance, assumes paramount importance if life insurers aspire to maintain their dwindling relevance among the global investment community."