Changing dynamics mean new opportunities in the insurance sector, equity analysts say.
Friedman, Billings, Ramsey & Co.
Area of Coverage: Life Insurance
Outlook: The industry outlook in the short term is similar to that of the long term in that I see a shift away from the traditional protection business towards the savings or accumulation business. The growth rate of insurance companies over the past 20 years has been in the low-single digits compared to the savings business that has been growing at 12 percent to 14 percent. Going forward, you should think of an insurance company as a place where you can save money on a tax-deferred basis or for retirement and then turn that savings into a lifetime stream of income.
Over the longer term, life insurance companies will become more like mutual fund companies than traditional insurance companies. But in the short term, what we have are new product introductions and guarantees targeted toward this savings side of the business.
Think of the savings business as consisting of two pieces. There’s the piece that’s linked to the equity markets. That’s the variable annuity business where returns vary. The other part is the fixed annuity business. Fixed annuities pay an interest rate based on Treasury yields.
The variable annuity business has been doing very well recently. That is being driven by the new guarantees insurance companies are offering that help purchasers manage risk related to downside in the equity markets and outliving their assets. That’s really the innovative corner of the savings business right now. Fixed annuities on the other hand have not fared as well. As interest rates have risen, CD rates offered by banks have also gone up and that has hurt the insurance company’s ability to sell fixed annuities. For example, two years ago you could walk into an insurance company and buy a fixed annuity with an interest rate of 4 to 4.5 percent. Banks might be offering 2 percent on certificates of deposit. Today, that is not the case. Now the rates offered by banks and insurance companies would be pretty similar.
Outperforms: American Equity Investment (AEL); KMG America (KMA); StanCorp Financial Group, Inc. (SFG); and Unum Provident Corp. (UNUM)
One of our Favorite Ideas: Unum Provident Corp.
Why Unum Provident? Our favorable rating on Unum is centered squarely on return on equity, or ROE, improvement. There are two things driving that, and one of them is improving the benefit ratio within the U.S. brokerage business.
As background, Unum has been forced to review denied claims under a multi-state agreement. The company was investigated and as part of the settlement, Unum went back and reviewed disability claims that had been denied. The process of doing that costs money, and some of those denied claims are eventually approved or overturned. That has pushed up their costs.
Now, Unum has a program in place to help address that increase in claims cost. If Unum does this, it is going to help their ROE. Claims are generally the largest expense item for an insurance company. So if Unum gets a little improvement on their benefit ratio, it will help its ROE. The second initiative the company is putting in place to boost ROE is to do a capital markets transaction. This would help Unum remove capital from some of its businesses, effectively lowering the “E” in the ROE equation. So, even if returns were to stay the same, if you reduce E, your ROE goes up.
Keefe, Bruyette & Woods
Area of Coverage: Life Insurance