Analysts at Barclays believe that life insurers should report strong earnings for the second quarter. However, the shifting macro environment will be a more important driver of share prices. The rising rates and the resultant steepening of the yield curve are positive stock price drivers for life insurers because it eases pressures on revenues, policy guarantees, and hedging costs. Since life insurance stocks are high beta, investors must brace for volatility.
Rising rates a benefit, equity market volatility a headwind
The 10-year Treasury sold off sharply during the second quarter driven by a shift in the Fed’s tone. The yields have already touched 2.5%, which are expected to surge to 2.9% when a halt to quantitative easing (QE) is brought after slowing down purchases in September this year. This rise in interest rates could mean higher revenues for life insurers.
However, the accompanied rise in volatility in the equity markets could be a headwind. A decline in the equity markets could impact profitability of insurers’ variable annuity and asset management businesses.
Large variable annuity business a concern
MetLife Inc (NYSE:MET) benefits from a diversified international platform although concerns about its large variable annuity business remain. The company is de-risking variable annuity products through a combination of price increases and benefit reductions, and is managing sales volumes within the range of $10 billion to $11 billion, which is down from $18 billion in the prior year. The company is applying an appropriate 10-year realized volatility assumption of 25%.
Metlife Inc (NYSE:MET)’s projected return on equity is within the range of 11% to 12% through 2014, which likely means its valuation multiples could remain compressed. The company’s focus on shifting business mix away from variable annuities to protection products with low capital requirements should improve return on equity. If MetLife lowers its reliance on its variable annuity business, it may be able to improve free cash flow and reduce its cost of equity capital.
Share buybacks could be restrained
Prudential Financial Inc (NYSE:PRU) has a strong international franchise, although the long-term return profile of its US variable annuity business is unclear and its US group insurance results are challenged. The management at the company expects the 2013 earnings to be driven by organic growth in the US and international businesses. The company is one of the most equity-sensitive life insurers.
I believe the company might be reluctant to execute significant share buybacks before the implications of its non-bank SIFI (systematically important financial institution) designation are clear. The company recently announced a new $1 billion share buyback program which was scattered over the next 12 months. This was to replace the existing share buyback program.
Focus on share buybacks
American International Group Inc (NYSE:AIG) is one of the world’s largest insurers, having a strong global footprint in property-casualty insurance and U.S. life insurance retirement savings. Over the past few years, American International made significant progress in de-risking the company and, in 2012, it was able to orchestrate a complete exit from U.S. government ownership. The capital management for American International appears to have upside, and you should expect significant share buybacks, which should be meaningfully accretive to EPS and book value. The company also appears closer to achieving its 10% return on equity goal by 2015. However, concerns about its property and casualty reserve position remain due to volatile financial markets. American International’s pending sale of International Lease Finance Corp. (ILFC) to a Chinese consortium appears to be in flux, and it could jettison the unit in an IPO. If American International is not able to sell ILFC, the number of shares repurchased may decrease.
The capital positions of most of the life insurers are strong. Meanwhile, most of them are also repurchasing their stock. Share buybacks could be restrained for Metlife Inc (NYSE:MET) and Prudential Financial Inc (NYSE:PRU), but you should expect robust share buyback for American International Group Inc (NYSE:AIG).