Challenges when valuing insurance companies in SEE region

Approach to the valuation of insurance companies

When valuing any insurance company appraiser has to deal with the following most important problems:


  • It is very difficult or maybe even impossible to define debt.
  • As debt is very difficult to define the computation of required rate of return (discounting rate) has its own particularities.
  • Regulatory requirements have very important influence on the value of insurance company, but can differ substantially from country to country.
  • It is very difficult or maybe even impossible to define changes in working capital and the amount of capital expenditure (CAPEX) needed.

Within appraisal profession these problems are solved by using different adjustments and changes to the usually used valuation models:


  • Since debt is hard to define appraisers tend to use equity valuation models instead of enterprise valuation models.
  • Therefore required rate of return is computed by using leveraged betas of comparable companies directly.
  • Due to different regulatory regimes, solvency ratios, credit ratings and other indicators it is very important to define the group of comparable companies used for computation of betas or multiples (if using market approach valuation) as narrow as meaningfully possible from the similarity point of view.
  • Since CAPEX in tangible and intangible assets is insignificant in insurance companies and working capital is very difficult to properly define due to problems in debt definition, models that use these parts of free cash flows are adapted in a way that these two items are not taken into account. Instead free cash flow definition for insurance companies includes changes in capital requirements as this item plays a significant role in insurance company’s operations and basically represents the actual CAPEX needs of insurance company.

Based on the above mentioned the following models are used for valuation of insurance companies:


  • Adjusted free cash flow to equity model demands that the definition of free cash flows is adapted for the purpose of insurance company valuation. Adjusted free cash flow to equity therefore equals to net income less reinvestment in capital. In this case it is very important how capital ratio is determined. Model is more suitable for valuation of majority ownerships.
  • Excess returns model is based on the sum of equity value of insurance company as of valuation date and present value of future excess returns that this insurance company will generate. This model is more suitable for valuation of majority ownerships.
  • Relative valuation models (market multiples) use multiples of comparable insurance companies, which results in the value of equity directly. Such multiples are P/B and P/E. Nevertheless the application of market data in form of multiples is very problematic since insurance companies have very different policies regarding capital ratios, ratings, strategies, regulatory requirements, etc. The comparable companies’ characteristics should therefore be very similar to the characteristics of insurance company being valued, when using this approach in valuation.
  • Asset valuation based models are rarely used and are suitable only for valuation of insurance companies with mature operations and little or no growth potential, as they do not take into account future expected returns of assets being valued. They are also suitable for valuation of companies, which are involved in several industries.

As expected all models that are being used by appraisal professionals for valuing insurance companies were developed in developed countries, where capital markets are active, market data of similar comparable companies is available and development of insurance services is high. But when appraiser faces the task of valuing insurance company from other, less developed environment like SEE region, additional issues and problems occur.

Specific characteristics of insurance companies from SEE region

Insurance markets in SEE are specific due to the following reasons:


  • In terms of diversity of insurance products available on the market as well as expenditures for insurance services per capita in GDP, insurance markets in SEE are underdeveloped.
  • Since those markets are underdeveloped high growth and more volatile operations is expected in the future.
  • Besides Solvency I regulative each SEE country has its own unique regulatory/legal constraints for insurance business.
  • Solvency II regulative will come into force much later on these markets (except Croatia and Slovenia) or it is not even known if it will and when.
  • Capital markets are underdeveloped and consequently available market data is not very good and can provide wrong information regarding actual value on the market.
  • Ownership structure of insurance companies on those markets varies significantly from company to company. Some of the most important insurance companies are still state owned whereas others are subsidiaries of bigger regional or international Groups or are totally local. Ownership plays an important role in strategic decisions, also regarding dividend policies, but due to the different types of ownerships present in SEE region these decisions are not necessarily connected with actual conditions on the market.

Due to these specifics of SEE insurance markets, models that are used for valuation of insurance companies in developed world are not always appropriate for valuation of insurance companies from SEE region or at least some adjustments to those models are necessary in order to come up with appropriate value.

Problems of applying different valuation models for valuing insurance companies from SEE region

Relative valuation models (market multiples) are based on the availability of reliable market data of comparable companies. But in SEE region market data of comparable insurance companies from this region is not very reliable and capital markets data is poor as well. On the other hand insurance companies from developed markets are inappropriate for comparison due to different stages of insurance markets development, growth rates, implicitly taken into account in this market data, regulative rules, etc. If appraiser still decides to value an SEE insurance company with this model, adjustments of multiples are necessary in order to compute the appropriate value. But adjustments are always considered to be connected with subjective assumptions, which appraiser generally tries to minimize as much as possible. In this case the number of necessary adjustments would be high, which makes such a method less reliable for appropriate value computation. In our opinion relative valuation models are therefore suitable only as so called control methods whereas more emphasis should be given to multiples of transaction with insurance companies from SEE markets.

Asset valuation based models are used only for valuation of insurance companies with mature operations, which have little or no growth potential. Therefore those models are not suitable for valuation of insurance companies from SEE region, where higher growth towards development of insurance markets is expected and markets are less stable and more volatile.

Another less appropriate model for valuation of SEE insurance companies is dividend model due to the fact that it is very difficult to determine suitable expected dividend (or pay-out ratio). Namely past data is usually not very useful as insurance companies in SEE markets are underdeveloped, have high growth potential, which demands higher reinvestments in capital, and their operations are not yet stable.

For valuation of insurance companies from SEE region adjusted free cash flow to equity model and excess returns model are probably the most appropriate to use by appraiser. But also those two models have some weak points and should be suitably adjusted based on the SEE markets’ specifics. One of the greatest problems represents the computation of appropriate discount rate since according to the theory it should be based on the market data of very much comparable insurance companies. In case of insurance companies from SEE region this is almost impossible since the insurance companies, which market data is available, differ significantly from SEE insurance companies (insurance companies from developed countries have totally different characteristics) or market data of those comparable insurance companies is questionable (underdeveloped capital markets in SEE region and low number of insurance companies on the stock exchanges).

As presented appraisers are facing a lot of challenges when valuing insurance companies from SEE markets and are forced to adjust valuation models accordingly in order to come up with an appropriate market value.