Should North American life insurers stop prioritizing share buybacks?
Insurers’ overreliance on buybacks
When you hear Wall Street asking about life insurers’ “capital return as a percentage of free cash flow or earnings,” what they are really focused on is the pace of share buybacks. According to our analysis, over the past decade publicly traded life insurers in Canada and the United States have returned approximately $275 billion in capital to shareholders through a combination of $190 billion in share buybacks and $85 billion in dividends.
The use of buybacks has been ubiquitous. Over the past ten years, 17 of the top 20 publicly traded life insurers in North America returned the equivalent of at least half of their market capitalization to shareholders through buybacks alone, according to our analysis. The appeal of buybacks is clear but often misguided:
- Higher share price. A reduction in outstanding share increases earnings per share; assuming the P/E ratio remains constant, the share price should rise. However, this doesn’t account for the value of the cash that has been paid out as part of the buyback and the impact it has on valuations and P/E ratios. Furthermore, this outcome neither involves the management team making strategic decisions about company projects nor signals intrinsic value creation.
- Market signals. Analysts and investors have been conditioned for years into thinking that life insurers were best served by returning excess capital to shareholders rather than investing it in the business, because many of these companies have not consistently generated returns above the cost of capital.
- Investor confidence. Buybacks can signal that the management team believes the insurer has deployable excess capital, which can provide an important boost in confidence for investors who have doubts about an insurer's reserves and capital adequacy.
Buybacks do not create value in and of themselves. They are “left pocket, right pocket” transactions that transfer cash from the balance sheet to shareholders, similar to a common shareholder dividend. While the shareholders that did not sell will own a larger share of the company’s equity, the life insurer itself becomes smaller and the value of the investors’ holdings remain the same.
Life insurers that primarily focus on share buybacks may also be taking an overly defensive posture, which McKinsey research on corporate resilience has found tends to lead to median company performance. Offense-only stances deliver a mix of occasional wins plus some catastrophic failures. The best leaders and companies are ambidextrous—prudent about managing the downside while aggressively pursuing the upside.
Finally, while many life insurers that have repositioned their business mix tend to generate improved free cash flow, a significant portion of their buybacks have been financed by one-time events such as divestitures and reinsurance transactions. As a result, these companies are likely to face increasing tension between maintaining historical capital return levels and reinvesting in growth; once a company is on the buyback treadmill, it’s difficult to exit.
A better approach: Focus on capital intensity
Our analysis found only a modestly positive correlation between life insurers’ share buybacks as a percentage of market capitalization and annualized TSR over the past decade, including the majority of the most recent life insurer IPOs. The analysis found even less correlation over the past two years between the pace of share buybacks and TSR. This means that life insurers’ path to increasing long-term TSR will not be primarily through maximizing share repurchases. (Notably, the lack of any long-term correlation between TSR and share repurchase intensity also extends beyond the life insurance industry.)