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IRI Speaker: Lack of Transparency about Hedging Strategies is Keeping Valuations Low

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A lack of disclosure among annuity manufacturers about their investment hedging strategies is depressing the companies’ stock valuations, according a stock analyst presenting at the Insured Retirement Institute’s 2012 Marketing Summit, which concluded on Tuesday. Held at the New York City Hilton hotel, the session explored factors impacting the VA carriers’ capacity and market performance.

“The lack of transparency is a significant factor contributing to the companies’ low [stock] valuations,” said UBS Securities Managing Director Andrew Kligerman. “Since the financial crisis [of 2007-2009] the investment community has been in the dark about the companies’ hedging strategies.

“Investors want to know more about the effectiveness and cost of hedging, the sensitivity of VA products to equity markets and interest rates, and where excess capital is going,” he added. Investors see these hedging strategies as a black box, which troubles rating agencies and analysts.”

Judged by conventional measures, said Kligerman, the VA writers—he flagged MetLife, which derives 10% of earnings from VA sales, Prudential Financial (15%) and Jackson National (20%) as the top three—should have better valuations. Many of the companies, for example, enjoy superior credit ratings and risk-based capital (RBC) ratios. They also have healthy net amounts at risk (NAR) and returns on equity.

But Kligerman noted that, since the end of 2006, valuations of VA writers are down 46%, versus the S&P index, which declined just 1% over the same period.  The companies’ price-to-book values (a ratio used to compared a stock’s market value to its book value) and credit default swap spreads also don’t align with otherwise healthy financials.

“If you look at the four strongest companies of the VA sector—Hartford, Lincoln, Prudential, and MetLife—the CDS spreads tell us that there remains concern among investors about the industry—concern that something can go wrong because, again, of the lack of transparency.”

Kligerman noted that Hartford Financial is “a fine company,” but the insurer got into trouble that forced it to exit the annuity business last month because the company didn’t properly hedge its capital. As a result, the company’s existing VA block of business is now “a drag” on earnings.

“Clearly, greater transparency is needed in the industry,” said Kligerman. “That will improve investors’ perception as to the sectors strength and unlock capacity for growth.

“We’re always seen new generations of VA products with higher ROEs [return on earnings]. “But these ROEs have to be coupled with more information as to soundness of the companies hedging strategies.”

Ramy Tadros, Kligerman’s co-presenter and a partners and leader of the Insurance Practice in the Americas for Oliver Wyman, said many VA writers are failing to meet investor expectations regarding disclosure of hedging practices because the companies view the strategies as proprietary. If disclosed, he added, the information might put an insurer at a competitive disadvantage.

As to federally or state-mandated disclosure of hedging practices, neither of the presenters viewed this as likely near-term. Nor did they see such a mandate as advisable, including for insurers that might receive a SIFI designation.

“If an insurer receives a SIFI designation, this will force the company to conform to capital reporting and reserving standards that apply to banks, which doesn’t make sense to me,” said Tadros.

Added Kligerman: “It’s very possible that the Federal government will require more hedging disclosure by insurers and VA writers, but we’re still at a very early stage in this process. The hope is we’ll get to a metric that’s more manageable and appropriate for the life insurance industry than would be required by a SIFI designation.”


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