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3Q 09 Results Should Be Strong for Capital Markets Sensitive Life
Insurers: We believe 3Q 09 reported results should prove to be strong from
most life insurers, particularly the capital markets sensitive variable annuity
writers, and companies with above average credit risk.
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However, Fixed Income Price Recovery Trade in Late Innings: While we
expect another quarter of strong book value growth for the sector in 3Q, we
struggle to see how much further mark to market book values can move with
fixed income prices now appearing relatively full (BBB corporate indices are
at 107% of par vs. 85% at year end 2008, high yield at 88 cents vs. 62 cents
at year-end 2008). Thus, following the strong results ahead for 3Q 09, we
think the book value recovery trade will be largely over for the life insurance
sector.
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Beyond Solid 3Q 09 Results, Getting More Cautious on Intermediate
Term Prospects for VAs: due to (1) Subpar ROEs for the next 2 to 3 years
as back book drag more than offsets higher margins on new business, and
(2) Capital Volatility leads to size constraints being implemented by most
companies, which has negative structural valuation implications.
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Unwound Carry Trades Not Coming Back: Aside from ROE pressure on
the sector from VAs, we also believe that 2006/7 ROEs benefited from carry
trades, that is, borrowing short and investing long, in areas such as GICs
and Funding Agreements, securities lending, and other types of spread
trades. Our sense is that these carry trades are not likely to come back, with
most companies holding onto excess liquidity levels vs. 2007 thresholds for
the next several years, which is likely to shave another 100 bps plus off the
average ROE for life insurers.
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Downgrading MET and AMP to Neutral/Upgrading SFG to Outperform:
Neither MET nor AMP are among the most exposed to VA risk in the sector,
but we don’t see material upside for either over the next 12 months if we
assume a discounted multiple is warranted for their respective VA
businesses. For SFG, our upgrade is driven by our view that it’s the
cheapest stock in the sector vs. 2010 net income, which demonstrates both
the quality of its investment portfolio and solid operating EPS visibility. We
are also changing our target prices (see Exhibit 1) and EPS estimates (see
Exhibit 3) for many of the companies in our universe.
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