From a low of 1.63% in May, 10-year Treasury yields jumped to 2.35% on the day of the recent Fed meeting, and are now hovering at about 2.5%. Insurers’ volatile and competitive market, consisting of commodity products, made them take on too much risk in the past and do everything they could to differentiate and gain brand loyalty.
As rates rise and the economy starts to recover, I will analyze three insurance companies with different core operating businesses: American International Group Inc (NYSE:AIG), MetLife Inc (NYSE:MET), and Assured Guaranty Ltd. (NYSE:AGO).
Repairing its reputation and brand
American International Group Inc (NYSE:AIG) is one of the largest insurance firms in the world. Through a wide range of subsidiaries, AIG’s core operations consist of Property-Casualty (69%), Life (29%), and in smaller percentages, mortgage insurance and other financial services. With current management repairing its reputation and brand, the transfer of ownership from the Federal Government to shareholders is now finished. AIG has shifted its focus towards reducing exposure to businesses with inadequate pricing, and increasing loss trends to help produce better margins.
American International Group Inc (NYSE:AIG)’s slow but steady growth has helped it achieve the confidence of the rating agencies. Property-Casualty business trend from mid-2011 shows a gradual improvement of the current accident year loss ratio which is now down to 63.2. Underwriting income will continually have risk from unpredictable worldwide weather-related events. Yet, AIG intends to grow internationally by a strategic investment in People’s Insurance Company of China, China’s largest provider of casualty insurance.
Life and Retirement are commodity-like businesses, and do not allow for product differentiation, keeping margins narrow. Life insurers are forced to match its long-term liabilities with long-term assets in order to manage balance sheet risk. At current rising rates, positive returns are threatened by increased unrealized losses in fixed income portfolios and policyholders surrendering contracts early for higher yield elsewhere.
I would recommend Buying American International Group Inc (NYSE:AIG), now trading at only 10.9 times earnings, a 40% discount to the industry average; business de-risking and focus on core operations reflects a stock favourable to reward shareholders through share buybacks and/or dividends.
Metlife Inc (NYSE:MET) is the largest life insurer in the U.S. by total assets. In 2012, the U.S. and Latin America contributed to 75% of the revenues, Asia 19% and EMEA 5%. MetLife provides life insurance for corporate customers that not only look for price in the market but for a tailor-made benefit suite; such as dental, accidental, and health. These entrenched relationships have helped keep a high persistency rate.
After failing the Fed’s capital stress test, Metlife Inc (NYSE:MET) exited the banking business early this year, and this has helped it regain its competitive and operating strengths. The rating agencies have been changing their negative outlook towards a more stable and positive one. However, MetLife’s investment portfolio skewed toward corporate debt, mortgage-backed securities, and real estate loans still suggests a high risk of write-downs if their rating downgrades. In addition, U.S. regulators could require insurers to hold more capital against some of these high-yielding investments.
Moreover, Metlife Inc (NYSE:MET) is now focused on expanding into the rapidly growing emerging markets. A clear example of this can be found in the acquisition of Provida, a Chilean pension fund manager that should enhance operating leverage and diversify the company’s product mix and return profile.
Metlife Inc (NYSE:MET) shares currently trade at 21.8 times its earnings, while the industry average is 18.1 times. MetLife has the potential to outperform its industry peers once the economy recuperates. Nevertheless, decisions like withholding share repurchases in 2013 and the challenging operating environment reduces investors’ confidence, justify a Hold recommendation.
Clever management in the past
Assured Guaranty Ltd. (NYSE:AGO) is a Bermuda-based holding company providing credit enhancement products to the municipal finance, structured finance and mortgage markets. In 2009, Assured acquired Financial Security Assurance, adding dominance in the municipal bond insurance. Before the crisis in 2008, Assured Guaranty avoided insuring the most dangerous bonds escaping severe rating downgrades, and it consequent bankruptcy, like it happened to its competitors MBIA and Ambac. As a result, Assured became the only remaining publicly traded active bond insurer, and captured most of new insurance written on the municipal level.