4Q Earnings Preview: Insurers Face Tough Times

As the fourth-quarter earnings deadline nears, analysts say the insurance industry is in better shape than it was in 2008 to weather volatile markets and economic weakness.

Reinsurance Group of America Inc., the global life and health reinsurer, kicks off fourth-quarter and full-year 2015 earnings after the market closes Thursday.

Capital and liquidity are stronger than they were eight years ago, credit portfolios carry less risk and the carriers with variable annuity exposures have scaled back, a pair of Morgan Stanley analysts said in a research note to investors.

“While this clearly is still a challenging environment for stocks, we feel the risk-reward for several names has begun to look compelling, with Ameriprise being our top pick,” wrote Morgan Stanley analysts Nigel Dally and Tanmay Gupta.

Carriers with the strongest liquidity positions are Voya Financial and CNO Financial, while companies with the strongest capital positions are Aflac and Ameriprise Financial. Companies with the strongest investment portfolios are Alfac and Hartford Insurance Group, the analysts wrote.

Aflac, Torchmark and Unum have no equity exposure to variable annuities, they wrote.

Industry analysts at Keefe, Bruyette & Woods said their top picks consisted of Voya Financial, Primerica Inc. and Ameriprise Financial.

“In a tough operating environment, we prefer companies with outsized capital return, lower sensitivity to long-term interest rates, and/or an ROE improvement story,” wrote analysts Ryan Krueger and Blake Mock in a note to investors last month.

Rate and Stock Market Scenarios

Varying economic scenarios favor different life insurer stocks based on the companies’ respective investment portfolios and capital management strategies. Assuming a rising 10-year Treasury note and a rising equity market, Lincoln, MetLife, Prudential and Voya are the KBW analysts’ favorite stocks.

In an environment with a flatter yield curve and a rising stock market, top stocks include Ameriprise, Principal Financial and Primerica, the KBW analysts added.

If rates rise again this year, but stock markets continue to tumble, CNO, Genworth and Unum round out Krueger’s and Mock’s top picks.

In a flat rate environment and falling stock market Aflac, Reinsurance Group of America and Torchmark finish as the analysts’ favorites.

The Federal Reserve raised a benchmark interest rate in December by a quarter point, but the Standard & Poor’s 500 index has fallen 7.9 percent since the beginning of the year. The S&P 500 closed 0.7 percent lower last year compared with the end of 2014.

Low Rates Remain “Biggest Fundamental Headwind”

KBW analysts said the life insurance industry’s “biggest fundamental headwind” remained low long-term interest rates.

Low rates make it more difficult for carriers and agents to sell life insurance products. They also make it more difficult for insurance company managers to earn investment income, the bulk of which is derived from bonds.

Industrywide, more than 70 percent of insurers’ investment portfolios are tied up in bonds of different quality. High-quality U.S. government bonds that pay lower interest than corporate bonds, hurt life insurers through a compounding effect.

Low rates depress carriers’ operating earnings by 1 to 3 percent annually, and over time builds up to a “far more significant level,” the KBW analysts wrote.

Spread compression, competitive pressures, increasing technology, infrastructure costs and regulatory expenses mean that most life insurer can expect revenue growth in the low-to-mid single digits in 2016, the KBW analysts said.

In addition, life insurers are finding it difficult to sell more insurance into the vast middle market, which is limiting carriers’ top-line growth. And a drop in the value of the stock market means lower fees on assets under management due to falling asset values.

As stock markets come under more pressure, “earnings from equity-sensitive products follow suit with lower fees on assets under management and potentially pressure on margins as revenues decline faster than companies can adjust their expense base,” Dally and Gupta wrote.

Bond Quality a Concern

Analysts will be looking at below investment grade corporate bond defaults, which have begun to rise with the collapse of oil prices.

Plummeting oil prices have raised questions about the ability of oil and gas companies to repay their bonds, though corporate bonds related to the energy sector represent 7 percent of average lie sector invested assets.

Lincoln Financial and Unum have the largest overall energy exposures and Hartford and MetLife the lowest, wrote Dally and Gupta.

Even with an improved capital position compared with 2008, “no two downturns are the same,” the Morgan Stanley analysts wrote.

“While housing-related structured securities were the main pressure point in the last downturn, energy exposures are clearly the area of most concern currently,” they wrote.

Higher risk bonds, which have some overlap with the energy sector, make up only 4.6 percent of the life insurance industry’s invested assets, KBW said.

Reinsurance Group of America, which analysts are looking for to deliver fourth-quarter operating income of $2.57 per share, kicks of a two-week earnings period for life insurers.

InsuranceNewsNet Senior Writer Cyril Tuohy has covered the financial services industry for more than 15 years. Cyril may be reached at [email protected].

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