Should North American life insurers stop prioritizing share buybacks?

Among life insurance companies in the United States and Canada, share buybacks have emerged as the preferred strategy for enhancing Total Shareholder Returns (TSR). Equity analysts have shown a strong interest in buybacks, with the words “buyback,” “repurchase,” and “capital management” collectively mentioned over 300 times during conference calls discussing quarterly earnings results for the 20 largest insurers in North America by market capitalization in the first half of 2022.

However, it’s important to note that buybacks may not significantly contribute to long-term share price performance for life insurers, as indicated by our analysis. Despite this, 18 out of the top 20 North American life insurers conducted share buybacks totaling $14 billion during the first half of 2022. This figure is equivalent to the entire market capitalization of a top-ten life insurer.

In this blog post, we will summarize our recent research on the predominant capital deployment strategy in the industry—buybacks—and explore alternative approaches that could potentially lead to superior share performance.

Overreliance on Buybacks: When Wall Street refers to “capital return as a percentage of free cash flow or earnings” in the context of life insurers, they are primarily concerned with the pace of share buybacks. Over the past decade, publicly traded life insurers in Canada and the United States have returned approximately $275 billion to shareholders. This sum comprises $190 billion in share buybacks and $85 billion in dividends.

The prevalence of buybacks is evident, with 17 of the top 20 publicly traded life insurers in North America returning at least half of their market capitalization to shareholders through buybacks alone over the past ten years. However, the appeal of buybacks can be misleading for several reasons:

  1. Higher Share Price: While reducing outstanding shares can increase earnings per share and potentially lead to a higher share price, it doesn’t account for the cash paid out as part of the buyback and its impact on valuations and price-to-earnings ratios. Moreover, this approach doesn’t involve strategic decision-making by the management team or signal intrinsic value creation.
  2. Market Signals: Analysts and investors have historically favored returning excess capital to shareholders rather than reinvesting it in the business, as many life insurers have struggled to consistently generate returns above the cost of capital.
  3. Investor Confidence: Buybacks can indicate that the management believes the insurer has deployable excess capital, boosting investor confidence in cases where doubts exist about an insurer’s reserves and capital adequacy.

In reality, buybacks do not inherently create value. They are essentially transactions that move cash from the balance sheet to shareholders, similar to dividend payments. While shareholders who retain their shares will own a larger portion of the company, the insurer itself becomes smaller, and the overall value of investors’ holdings remains unchanged.

Life insurers that primarily focus on share buybacks may also adopt an overly defensive posture, which research on corporate resilience has shown to lead to median company performance. The most successful leaders and companies balance defensive measures with aggressive pursuit of growth opportunities.

Furthermore, some life insurers that have repositioned their business mix to enhance free cash flow have financed a significant portion of their buybacks through one-time events like divestitures and reinsurance transactions. Consequently, they may face increasing tension between maintaining historical capital return levels and reinvesting in growth, making it challenging to exit the buyback cycle.

A Better Approach: Focus on Capital Intensity: Our analysis reveals only a modestly positive correlation between life insurers’ share buybacks as a percentage of market capitalization and annualized TSR over the past decade, including for most recent life insurer IPOs. Additionally, there is even less correlation between the pace of share buybacks and TSR over the past two years. This suggests that increasing long-term TSR for life insurers will not primarily depend on maximizing share repurchases. (Importantly, the absence of a long-term correlation between TSR and share repurchase intensity extends beyond the life insurance industry.)

Instead, our analysis points to a life insurer’s business mix (specifically, the proportion of capital light versus capital intensive elements based on earnings contribution) as a more significant driver of long-term share price performance. Our regression analysis indicates an R2 value of 5 percent, signifying a low correlation between buybacks and TSR (see Exhibit 1).

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A capital-light strategy typically focuses mostly on products with little or no guarantees, such as employee benefits, protection-oriented life insurance, retirement services, and wealth and asset management. A capital-intensive strategy, on the other hand, involves a greater focus on products such as universal life, variable annuities with living benefits, or legacy products with robust guarantees. In general, the research found that capital-light life insurers generate above-average share price performance relative to the level implied by their pace of share buybacks. Meanwhile—despite that in several cases capital-intensive carriers have repurchased shares over the past decade equivalent to more than 100 percent of their market capitalization—life carriers with a capital-intensive strategy tend to generate below-average share price performance.

Among life insurers whose valuation multiples have expanded over the past five to ten years, at least several have shifted away from capital-intensive, opaque lines of business into capital-efficient, easier-to-understand lines of business. “Unbundled” business models can also promote value creation because they can lead insurance carriers to focus on sources of distinctive value creation while seeking partnerships or leaving other parts of the value chain to those with a more natural advantage.

There are examples of several leading life insurers meaningfully reshaping their business by exiting capital-intensive businesses and shifting the capital previously supporting these units into capital-light businesses with attractive margins and ROE profiles. Investors recognized these favorable shifts, which were reflected in superior TSR as well as price-to-book valuation multiple expansion (Exhibit 2). These insurers also generate improved excess capital, which is returned to shareholders through dividends and buybacks—but clearly it was the changes in strategy that improved their positions, not the buybacks themselves.

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