Valuation of Financial Service Firms: Insurance and Asset Management

1
Valuation of Financial ServiceFirms Insurance
and Asset Management

• Week 3 September 7, 2006

2
Introduction to insurance industry

• Assessment of financial performance performance
• Application of analysis of financial information
  to understand reasons for performance variations
• Think about valuation issues in terms of
  insurance application to PV-FSI

3
Case Discussion AIG

• Performance
• Organizational structure
• Factors determining of performance
• Sources of variability
• Cash flows

4
AIG, Torchmark, and SP Index
5
AIG, Torchmark since 9/11
6
Valuation of Financial Firms

• Best approach is based on discounted cash flows
  and, following Copeland et al, we use cash flows
  to equity
• Spreadsheet PV-FSI is abbreviated but captures
  more complete models
• You are free to change the spreadsheet
• Add product lines (we will discuss PV-LIC-2003
  this week)
• Change forecast and continuing value periods

7
Valuation and Projections

• Dividendable cash flows correspond to cash flows
  to equity
• Spreadsheet has two years of history and a five
  year explicit forecast horizon
• Continuing value captured with multipliers of
  fifth year values
• Book-to-market
• Price-earnings
• Value drivers approach (see Copeland et al)

8
Valuation of Financial Firms

• Liabilities are not just funds like debt but
  contractual obligations
• Deposits
• Insurance contracts
• Dividendable cash flows to equity are Net
  income Non-cash expenses - Required equity
  growth
• Equity must support balance sheet
• Regulation
• Risk

9
Assumptions

• Need estimates of contractual cash flows from
  liabilities (service costs, benefits, etc.)
• Need to estimate adjustments to cash from
  non-cash expenses (depreciation, provision for
  loan losses, amortization of deferred costs)
• Must assume a required equity

10
Valuing Insurance Companies
11
Detailed Analysis of Operations
12
Ratios for Assumptions
13
Valuation Cash Flows
14
For Next Week

• Prepare to discuss Chapter 8
• We will discuss underlying economics of value
  creation in financial services
• We will discuss how value is created in
  credit-related services discussed in Chapter 8
• Part I of project is due Thursday