Recessions and low-interest rate environments are never bullish for insurance companies, but sometimes good management can make the adjustments necessary to thrive in a tough economy, writes Tom Slee of The Canada Report.
Canadian insurers were glad to close the book on 2011. Squeezed by low interest rates and stagnant economic growth, the major firms struggled. Some even incurred bottom-line losses and started retrenching.
On the casualty side, it was another year of natural disasters that cost the industry $108 billion. Only 2005, the year when Hurricane Katrina came ashore, was more expensive.
No wonder insurance stocks suffered. The TSX Insurance sub-index dropped 24% in 2011.
Obviously, it’s a gloomy picture, and a lot of investors have written off the sector. There is substantial short selling. My feeling, though, is that most of the bad news is behind us.
This is a resilient, regulated industry, well equipped to survive and recover. Moreover, a lot of the damage was self-inflicted, certainly amongst the major lifecos, which were heavily exposed to the equity markets. Repairs are underway, and we may be pleasantly surprised by earnings growth in 2012 and 2013. Let us take a look at the life insurance companies first.
Life Insurance Companies
When the staid, low-key Canadian life insurance companies de-mutualized 15 years ago, we expected some dramatic changes. Nobody, however, anticipated a widespread upheaval.
The industry has been revolutionized. Most of the smaller players have disappeared, and we are left with a handful of performance-driven giants. There are new, aggressive management styles and different priorities. The days of conservative reserves and cautious dividend increases are long gone.
Worldwide expansion has become the name of the game. High-flying Sun Life (SLF) and Manulife (MFC) mushroomed by cutting premiums, peddling equity-linked products, and riding high interest rates coupled to a soaring stock market. They went out on a limb…and then came the 2008 crash. The lifecos have floundered ever since.
It was quite a ride. Now, however, the turmoil has subsided, and companies are taking steps to improve the situation. Sun Life recently announced plans to stop selling unprofitable life and variable-rate annuity policies in the United States. At the same time, its agents are emphasizing wealth-management products that have lower capital requirements.
Manulife has raised long-term-care premiums, taken a $1 billion charge against US subsidiary John Hancock, and belatedly started hedging its exposure to the stock market.
It’s all very promising, but the thing that worries investors most is low interest rates. As a rough rule of thumb, insurers make half their money by investing premiums in the bond market, pocketing the income, and paying out claims.
Fixed income is the industry’s life blood. As a matter of fact, the insurers’ portfolios are so heavily weighted in bonds that Julie Dickson, Canada’s Superintendent of Financial Institutions, is concerned about the sovereign debt downgrades. She has warned the industry not to reach for lower-quality issues in an effort to increase returns.
My feeling is that while prolonged low interest rates are going to be a problem, they are not a serious threat. Actuaries and analysts are confident that lifecos can cope with a flat interest rate environment for the next four years and generate growth.
Assuming a modest improvement in equity markets and unchanged fixed-income returns, Canadian life insurance profits are likely to increase 7% in 2012, and a further 8% in 2013. Some companies should do even better.
For example, analysts expect Great-West Life (Toronto: GWO) to earn C$2.20 a share this year, with a 10% improvement to the C$2.45 range in 2013. Manulife should also show much better numbers, and that is why I am reinstating it as a buy.
Subscribe to The Canada Report here…
Related Reading:
