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Selective Strength

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Insurers with better capital and assets, as well as superior underwriting and growing earnings, offer investors good opportunities at this time, analysts say.

Jukka Lipponen, CFAKeefe, Bruyette & [email protected]

Jeffrey SchumanKeefe, Bruyette & Woods

[email protected]

Valuations have changed significantly on asset concerns.

Asset issues continue to rule the life-insurance stocks, which are less exposed to subprime and other housing credits than other financials and have exposure to other credit markets.

It is a mixed picture from here: Expect more GAAP mark-to-market and impairment damage over 2008 and expect statutory capital positions to remain solid.

Thus, the implications are, for investors to buy selectively, based on their time horizon.

Favorite IdeasIn the large-cap space, specifically looking at the near-term and all-around picture, AFLAC Inc. (AFL) has strong capital and asset quality, margin expansion and a Japan sales catalyst in 2008-2009. In the small- and mid-cap arena, Assurant Inc. (AIZ) has a strong capital position and generation, high asset quality and excellent underwriting results.

In the intermediate term for Prudential Financial Inc. (PRU), the strong capital dwarfs asset issues, franchise value is unchanged despite the historic low P/E ratio, and asset marks and Japan expense muddy the first half of 2008, but we expect upside from there.

Also in the small- and mid-cap space, Phoenix Companies Inc. (PNX) has growing life and annuity earnings, its asset-management spin clarifies valuation, and the stock is trading at a significant discount to any reasonable estimate of “real” book value.

Baseline ScenarioIn our base scenario, the GAAP mark-to-market impact ranges from 1 percent (AFLAC, Torchmark Corp. (TMK), Universal American Corp. (UAM), and Unum Group Inc. (UNM)) to 11 percent (FBL Financial Group). The biggest exposure is to subprime and commercial mortgage backed securities.

In the STAT output, statutory capital holds up well in our scenario. The companies with the biggest capital margins (Prudential Financial, AFLAC, Ameriprise Financial (AMP), and Assurant) retain big margins in our scenario. Protective Life Corp. (PL) and Reinsurance Group of America Inc. (RGA-A) are well capitalized, but have smaller margins. The biggest area of potential loss exposure: corporate bonds.

GrowthThe individual life market continues to grow at a modest mid-single-digit pace. The rationalization of distribution costs remains a challenge.

Variable annuities continue to expand; industry net flows remain positive. Fixed annuities remain in net outflows. Group insurance growth is restrained by lost wallet share.

ProfitabilityUnderwriting: Life mortality and disability morbidity have generally been good in recent quarters. Downside risks include (1) industry capacity exceeds industry growth, which may impact pricing; (2) a recession may impact disability results.

Interest spreads: A better yield curve may help, but alternative investment returns have likely peaked.

Fee/equity: The market is down in 2008; guarantees continue to proliferate.

RatingsOutperform-Best Ideas: AFLAC (AFL), Assurant (AIZ)

Outperform: Ameriprise Financial (AMP), Conseco Inc. (CNO), Lincoln Financial Group (LNC), MetLife (MET), The Phoenix Companies (PNX), Prudential Financial Inc. (PRU)


Christopher Hitchings Keefe, Bruyette & Woods+44 20 7663 [email protected]

Equity Focus: European InsuranceAEGON N.V. (AEG) has come through 2Q08 in better financial shape than might have been imagined. While profits may have been a touch below hopes, underlying trends are solid and, most significantly, new business remains robust and net flows have swung strongly positive. The inevitable short-run risks in current turbulence are well appreciated in the very modest share rating. Less so are the defensive merits of a purveyor of stable-value savings products. Our forecast cuts of July still look on the cautious side, as does our EUR13 target price. We remain Outperform.

AEGON’s focus on spread-based products is likely to see its sales hold up better than its peers in tough markets, as attested by the 3 percent growth in life sales and strong improvement in net flows in 2Q08. Not only should such ‘stable-value’ products sell well, the reappearance of upward-sloping yield curves and sensible credit spreads means margins on these products are improving.

One legacy of its 2001-02 traumas is an extremely cautious approach to capital and risk. AEGON’s excess capital – over an S&P AA rating with buffers – remains at EUR0.8bn as at June and its total excess of deployable over required capital is EUR1.8bn, an increase of EUR0.2bn over March’s position. Since June, it has released a further EUR0.3bn through securitization.

Most life insurers are good value, but AEGON trades on a PER at least 20 percent below that of its European or U.S. peer group.

New CEO Alex Wynaendts has set the group’s new targets, and there are serious initiatives to ensure these are achieved. We believe a secular improvement in the group’s growth trajectory is already underway and see the strong improvement in net flows as confirming this trend.

Q208The U.S. premiums business is much as we expected, with better trends in retail business offsetting still low institutional production.

Offsetting this was a very strong rise in fixed annuities. This reflected the positive market background of an upward sloping yield curve, higher credit spreads and increased demand for stable value products given equity market turmoil. It also reflected an important new bank distribution channel. Variable annuities are marginally ahead of both 2Q07 and 1Q08, something of an achievement, although this also reflects the coming on-stream of new distribution, including a full quarter of Merrill Lynch.


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