Unlocking ROE Potential: Gauging the Scope & Likelihood

Research evidence excerpt

Unlocking ROE Potential: Gauging the Scope & Likelihood

FoundationM

Executive Summary

This report analyzes ROE using the variables of (1) profitability, (2) diversification effect

and (3) financial leverage, to determine where and how much upside there is for individual

insurance stocks, and considers the likelihood of this upside materializing.

(1) Profitability (return / gross risk)

Our analysis defines profitability as return (adjusted earnings for nonlife insurers; value of

new business plus expected return for life insurers) divided by gross risk. For nonlifers, we

analyze adjusted earnings separately for (a) domestic nonlife business, (b) domestic life

insurance business and (c) international insurance business; for life insurers, our analysis

considers long-term drivers of EV (a) the value of new business and (b) expected return.

(2) Diversification effect (net risk / gross risk)

We measure the diversification effect by dividing the amount of net risk by the amount of

gross risk. For both life & nonlife insurers, we examine scope for diversification effect

build-up based on the balance of risks that maximizes the diversification effect.

(3) Financial leverage (qualifying capital / net risk)

We examine scope for reduction in financial leverage from the ESR (economic solvency

ratio) perspective of qualifying capital divided by net risk. With their disclosed ESR target

floors in mind, we determine upside if ESR decreases to 200% for nonlife insurers and to

185% for life insurers.

Note that, in principle, ROE is return based on company guidance (adjusted earnings for

nonlife insurers; value of new business plus expected return for life insurers) divided by

qualifying capital and that risk values and other metrics do not necessarily match the