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Insurance - Life/Annuity
State of the Industry —
Moving to Attractive
We are raising our life insurance industry view to
Attractive from In-Line. The forceful headwinds
including the collapse in equity market levels and severe
fixed income spread widening appear to be abating,
which raises the possibility that we are entering a new
era for the group where traditional metrics including
growth and profitability re-emerge as key valuation
drivers. While it is unlikely that ROEs will return to the
levels enjoyed prior to the global credit crisis, we
nonetheless expect book values to move materially
higher and return prospects to improve as expense
reduction initiatives begin to take hold and excess
liquidity currently held by the group is put to work,
leading the group to outperform the broader S&P500
index. As part of raising our view on the industry, we are
increasing our rating on Principal to Overweight, with
capital and liquidity concerns having been significantly
reduced following its recent debt and equity offerings.
Key positives: (1) Concerns about capital adequacy
have diminished following recent debt and equity
issuances and the government backstop; (2) Reported
book values are likely to rise 20% on average in 2Q09
due to spread narrowing; (3) Earnings power is being
restored by expense reduction initiatives and a return to
normal liquidity levels; and (4) Valuations look attractive
versus other financial services groups such as banks.
Valuation upside: Despite a solid rally in the industry,
the group is trading at 6.5 times 2010 EPS and 0.7 times
book values excluding AOCI. Over 12-18 months, we
see another 30-40% upside on average. While we still
see solid upside in the more defensive names, we also
recommend investors consider adding exposure to the
more equity sensitive names with solid franchises such
as Principal Financial.
Risks: The severity and timing of credit losses remain
difficult to gauge, although recent trends have been
encouraging. Also, the rally in financial markets could
reverse, although retesting the lows is looking less likely.
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