By Warren S. Hersch
The U.S. life insurance industry
has returned in the aggregate less than its cost of equity since 1985, according to a new report.
McKinsey & Company, New York, discloses this finding in “The Life Journey: Winning in a Risk-Driven World.” The report addresses risk skills that affect company performance, industry opportunities and challenges and strategic implications of the current market environment for life insurers.
The report reveals the life insurance industry’s return less the cost of capital barely hovered in positive territory during the periods of 1985-1993 (1.6 percent) and 1994-2002 (0.6 percent). Since then, the industry has yielded an average negative return (-2.5 percent).
In 2011 (the most recent year for which data is available), the industry’s return minus the cost of the capital was -6 percent, the worst year recorded by McKinsey since the downturn of 2008, when the net return on equity
was -30.6 percent. In the intervening years, the industry posted negative net returns of -3.0 percent (2009) and -1.9 percent (2010).
“In effect, the huge losses in 2008 were the flip side of overstated returns from 2003 to 2007,” the report states. “Further, the continuation of lower-than-cost-of-capital returns from 2009 to 2011 is in sharp contrast to the turnaround in industry results following poor returns in 2002. In short, we see 2008 as an indicator of the fundamental shift in the industry’s risk profile rather than an aberration.
“Before 1985, the industry enjoyed limited volatility
and relatively consistent returns above its cost of equity,” the report adds. “Its cost of capital was lower and investors perceived it as a more stable and profitable sector.”
The report correlates the industry’s rising volatility and cost of equity. Between 2008 and 2011, when the average cost of equity ranged from 10.8 to 11, long-term expected volatility (beta) ranged between 1 and 1.4. This compares with an average cost of equity varying between 8.2 and 10.8 and beta values between 0.6 and 1.0 from 2000 to 2007.
Originally published on LifeHealthPro.com