Can we explain the stock market path of insurers?

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Like other listed stocks, the course scholarship holder of most insurers, since the start of 2021 is impressive: the price of Axa has risen by 21% in 8 months when the rise in the CAC 40 stands at 20%. Abroad, the price of Italian Generali is up 23%, that of Spanish Mapfre by 15%, that of Dutch NN by 23% and that of English Aviva by 28%. Can we identify the catalysts for these developments when the specific features of insurance companies do not seem compatible with traditional valuation approaches?

The stock market course generally reflects the forecasts of financial analysts. The latter tend to make a certain number of hypotheses that make it possible to reconstruct a business plan or business plan of the company for which they determine a price target. This is the result of a multi-criteria analysis of the value of the company. Among the methods retained, the so-called DCF approach (Discounted Cash Flows) occupies a central place. It consists of discounting future cash flows, the sum of which is the enterprise value. The value wanted equity is then obtained by deducting the net debt from the enterprise value. Inapplicable to banks for which the notion of net debt is not relevant, this approach could theoretically be retained for insurance companies. However, this does not take into account a fundamental point specific to financial institutions: the prudential capital requirements generated by their activity.

In the current regulatory environment, insurance companies must in particular display a level of equity at least equal to the losses that would be recognized in the event of a major shock; it can be a sinister exceptional in non-life insurance, the effects of a pandemic in health insurance or a sharp deterioration in the solvency of counterparties in credit insurance. The need to equity, still called Solvency Capital Requirement or SCR, depends on the risks taken by the insurance company in terms of the subscription of contracts, the counterparty, in particular within the framework of its holding of portfolios of bonds, and the market. If the solvency ratio which relates prudential capital to SCRs is less than 100%, the continuation of the activity of the insurance company is conditional on approval by the supervisory authority on which it depends (the Prudential Control and Resolution Authority or ACPR in France), a plan that describes the measures to be implemented to bring the ratio at an acceptable level. More than the activity of the insurance company, it is its very existence which depends on the ratio of solvency.

The centrality of the solvency ratio in the management of an insurance company leads to its integration in the valuation process. Within the framework of a method known as DDM (Dividend Discount Model), the intrinsic value of a company is equal to the sum of the discounted future dividends that could be paid in compliance with a solvency ratio that it aims (or target ratio) or that the regulator specifically imposes on it. This is not the dividend that will actually be paid to shareholders, but a theoretical dividend equal to the net result reduced by the consumption of own funds induced by the growth in the risks of the company. This consumption capital corresponds to the application of the company’s target solvency ratio to the growth of its SCRs. By way of illustration, a profit of 100 M € combined with a growth in SCR of 30 M € leads to a theoretical dividend of 70 M €, assuming a target ratio of 100%; if this target ratio is set at 200%, the capital consumption is increased to € 60 million and the theoretical dividend is reduced to € 40 million. The progression of the intrinsic value of an insurance company therefore requires both the growth of its profits and the reduction of its risks, and therefore of its SCR.

During the first months of 2021, the measures to support the economy taken by the French government, combined with the clarification of the horizon allowed by the vaccination, favored the resumption of consumption. This constitutes a source of improvement of corporate profit outlook. In addition, for insurance companies, there are three specific elements that constitute as many vectors of growth in their value.

First, the French Insurance Federation (FFA) announced at the end of July 2021 that, despite the recovery in consumption, life insurance recorded a record month of June during which its collection gross savings reached nearly 14 billion euros; this brings the total amount of contributions collected by French insurance companies to 77 billion euros in the first half of 2021. The total outstanding life insurance contracts thus came to 1840 at the end of the first half. billion euros, up more than 4% year on year.

In addition, the month of June 2021 was marked by the confirmation of a basic trend: the lower risk inversion of life policyholders, which leads them to take out more and more unit-linked (UC) contracts. Thus, the proportion of contributions in UA represented 41% of total contributions in June, against 38% on average since January and 35% in 2020. In a UC contract, the capital risk is assumed by the life insured while, in a euro contract, this risk is borne by the insurance company . Thus, the new balance in the life insurance market between contracts in euros and contracts in unit-linked funds makes it possible, at constant total outstandings, to reduce SCRs and therefore the prudential capital requirements of insurance companies. With regard to the logic of the DDM approach, this results in an increase in the theoretical dividend, and therefore in the value of the insurance company.

Finally, a study published on 1^is September 2021 by Euler Hermès reveals that public support for the economy in the context of the health crisis has made it possible to reduce the proportion of SMEs in potential bankruptcy, compared to pre-crisis levels. More generally, the reduction the probability of bankruptcy corresponds to an improvement in the counterparty risk borne by the insurance company. This results in a decrease in SCR, and therefore in capital requirements, which once again has a positive effect on the value of the security.

Most insurance companies therefore seem to benefit from an alignment of the planets: increase in consumption and therefore of insurable material, growth in life insurance, interest of savers in UC contracts and reduction in counterparty risk. Thus, the proven growth of their profits is not the result of a surge in their risks and therefore their SCR and their capital requirements, which favors the stock market course of their securities.

Written by Olivier Levyne is Professor of Finance at ISC Paris

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