RS Investments Comments on Willis Group Holdings
Willis Group Holdings (WSH) is the world's third largest insurance broker, in an industry where 78% of the market share is held by the top six players. The company operates as an intermediary in placing both insurance and reinsurance coverage. Approximately 70% of company revenues are generated through commissions and over 93% is recurring. Willis Group's is the world's largest reinsurance broker and more than half of its cash flows are generated outside the US. The company holds minority interests in Gras Savoye (31%), a French brokerage firm, and Al-Futtain (49%), a Dubai brokerage firm. CEO Joe Plumeri was the primary architect responsible for transforming the company after it was acquired by KKR Holdings in the late 1990s.
We believe that Willis Group is very well positioned to benefit from a sustained increase in property and casualty insurance pricing, which should reverse a multi-year downturn that has significantly reduced returns for underwriters. We believe that improved pricing is inevitable because: (1) the insurance industry is now cash flow negative on an underwriting basis, with paid losses now outpacing paid losses + changes to overall reserves; (2) Investment yields have declined dramatically due to low interest rates. New money yields now average 2.75%, compared to five years ago when they exceeded 5%. Given the industry's dependence on investment income and the underwriters' use of leverage, returns have declined materially; (3) The industry has been living off of reserve redundancies for the last several years, such that now reserves are developing adversely, which is putting additional pressure on balance sheets and capital positions; and (4) 2011 was the third worst catastrophe loss year on record, which led to over $100 billion in insured losses.
Willis Group produces consistent cash flow generation and, therefore, its stock price is less volatile during pricing downturns. The company enjoys long-term relationships with its clients, which range from small businesses to global Fortune 500 companies, and these revenue streams are very sticky (93+% persistency). Property and casualty insurance is a necessity for business customers and requires that they return to their broker at least once a year; and the broker collects the same commission regardless of whether it is for new business or renewal. Even during cyclical downturns, most brokers are able to increase the amount of insurance a business receives by changing terms and conditions so as to keep absolute pricing relatively flat. Despite the recent soft pricing environment and the global credit crisis, organic growth for the industry has remained positive for each of the past 12 years. For these reasons, we remain confident in our belief that our investment in Willis Group provides our investors with a compelling investment opportunity with ample downside protection.