The Changing Face Of The US Insurance Industry: Race For Survival

The past year has truly been one of misery for many industries, most particularly, the financial sector. The insurance industry has been one of the hardest hit in recent times. Many of the companies have lost a vast amount of share value in the past month, and conglomerate American International Group (AIG) is still reeling from its credit swaps and loans to the U.S Government. A global recession has hurt all aspects of their industry, with profits and revenues related to life insurance being the worst hit.

The year 2009 will be a trying time for the industry, with a competitive race for survival among the incumbents. Below is a list of the primary competitors along with an assessment and predictions for future power in this changing industry.

MetLife

MetLife (MET) is the largest U.S. Life insurance company that primarily deals with customers in the U.S., Central America, Europe, and Asia. As I stated in an earlier article, Metlife appears to have encountered the worst of its problems and is now poised to expand. They were the first insurance company to raise an extensive amount of capital and are in a relatively stable financial condition. Most companies are taking a defensive capital stance, yet MET’s solid financial positioning will offer the company the resources to be active as well as the opportunity to acquire assets to the detriment of their competitors. Management is also a crucial part to the strength of Metlife.  They hold the key to one of the strongest investment portfolios, which is valued at approximately $322.5 billion. They are considered to be in a very secure position, and their relatively conservative assets’ portfolio is a substantial benefit.

Metlife’s management has stated that they would like to continue to develop their foreign market share.  It is also very likely that they will get involved with the AIG asset off-loading that is predicted to happen in the near future. MET has the greatest potential to expand and is already seeing growth in revenues in their Chinese and Japanese markets.

MET’s financials remain very strong.  MET is in the top quartile of their industry in almost all major categories, with very respectable revenue growth of 14.6%. They also posted one of their highest EPS’ last year, with annual earnings of $4.14 a share, despite some of the worst circumstances ever for insurance giants. Management believes that this growth and stability amid crisis only provides further credibility that MET is better equipped to survive a recession and is positioned to emerge as the insurer of choice going forward.

AIG

American International Group has plummeted in recent months following their risky credit default swap endeavors of 2008. It appears as though $150 billion of bailout funds may not suffice, as it is very likely that they will receive additional monies from the government.  This comes in light of news that AIG posted 4th quarter losses of -$61.7 billion, and over -$100 billion in the past 5 quarters.  Even scarier is the fact that this company has a present value market cap of only $1.4 billion dollars. AIG’s original problems stemmed from its selling credit default swaps, insurance contracts to back up collateralized debt obligations. When the value of these swaps plummeted, AIG was forced to cover the difference by paying more capital. AIG also took a major hit from its MBS (mortgage backed securities) exposure and was forced to take billions in write downs as the housing crisis escalated. The result was an original bridge loan received from the government for $85 billion which was later revised.

Already in an appalling situation with the government owning 79.9% of their equity, additional support would likely warrant adding AIG completely to the federal balance ledger. The equity value of AIG has become extremely diluted and is no longer a safe or a conservative investment.  They also have lost the ability to pay its original bridge loans back to Uncle Sam unless a huge restructuring occurs. It is likely that they will offer some of their assets as payment, but this will prove to be tricky as it will be very difficult to lock-in on a fair market assessment when everything is in such rapid decline. In addition, AIG also struggles because of the strict government oversight required as a result of their taking significant aid. This has caused AIG to lose key management and employee talent to competitors and has formed a more rigid and regulated business environment.

I don’t foresee AIG aiding any shareholders, but rather other insurance companies looking to expand their asset holdings at a bottom price. It is unlikely that this company will be able to independently move forward, and speculation is very high that the company will be split into three sub-sectors that will be controlled by the government. I anticipate the government taking either managerial control of these businesses or to take complete control of high valued assets to pay back the loan. I feel that this will lead to the eventual auctioning off of these valuable assets to other companies because the government does not intend to be in the insurance business long-term.

Allianz

Allianz (AZ) is Europe’s largest insurer, dealing primarily with insurance but also banking and asset management services. They are a German based company that appears to be in decent standing for the coming year. They posted larger than expected losses, but this comes in light of the sale of their Dresden Bank asset to Commerzbank. The losses realized from this sale comprised a large percentage of there -$3.8 billion quarterly losses. Management, in their 2008 financial press conference, admitted that this was a mistake given the economic climate which has hurt them since 2007.

It appears as though the worse is behind AZ, as the sale of Dresden has now given them a solvency rate of 161%. In today’s economy, this is a tremendous bonus that ranks them near the top of all their competitors. Worldwide, they also rank #1 in property casualty insurance, #8 among all life insurers and #2 among all asset managers. They are the second largest insurance company in the world in terms of market capitalization.

The size of their asset management division would appear to be a weakness due to the problems created in their equity markets, however, 85% of the portfolio is in fixed income asset management, with the rest in equities and a mere 2% in the real estate market. They are also extremely underweight in the variable annuities market, which provides yet another buffer from the market conditions. This has safeguarded them from the financial crisis, with Michael Diekmann, Allianz CEO, stating that they had learned from the crisis in 2001-2002 and had prepared by having extra capital and a more efficient, less complicated structure of management.

AZ appears to have positioned itself well, and with an already expansive global presence, they should be able to remain a top competitor in the insurance industry. They are ranked as a top 5 competitor in 27 countries around the world. Due to their size and financial positioning, I see them staying relatively conservative in the near future, especially after being burned by the Dresden acquisition. However, that being said, they are still a good company that issues respectable dividends and appears to be a safe play.

Aflac

Aflac Incorporated is a health and life insurance provider through its subsidiary, American Family Life Assurance Company of Columbus (AFL).  While headquartered in Columbus, Georgia, and providing insurance throughout the United States, most of AFL revenues are earned in its Japanese market.  Over the past 3 years, annuities from Aflac Japan have actually returned 72% of their annual revenues  while holding 87% of their total assets.   Aflac Japan’s greatest asset is their cancer policies which successfully funds a large percentage of the entire company.

Aflac has hurt itself by being over ambitious with its investment portfolio.  They are one of the few companies who have not yet faced their stiffest challenges.  They are still extremely susceptible to European bank troubles because of their investments in subordinated financial instruments, “hybrid securities.” These investments in hybrid securities total approximately $18.5 billion.  This number is over one quarter of Aflac’s total debt and perpetual securities as of their latest 10-k filing.  Of this, $9.1 billion in securities has no maturity date which is very harmful because Aflac does not know for what period they are susceptible to losses.  This safeguards them in the short term with only $306 million due in 2009. In addition, they experienced losses in their CDO’s (collateralized debt obligation) market due to the credit crisis.

Their investment portfolio appears aggressive and laden with risk, and thus may come back to haunt Aflac in 2009.  Also, Aflac posted nice returns in the fourth quarter because 70% of the Japanese annuities’ market is demanded in Yen, and with the significant currency appreciation of the yen, inflating earnings.  Yen also is the denomination of almost all of their securities, and they have been hurt with almost all investments in the Japanese economy in the last 2 years due to the poor interest rate curves.

Historically, Aflac has proven to be a fairly reliable company; however with numerous obligations to European banks, and a reliance on the Japanese economy, one may question their investment strategy.  Aflac will have to await the end of the credit crisis and hope for a strong Japanese economy in order to achieve quality returns.

Prudential

Prudential (PRU) is the second largest life insurer in the United States.  They have operations in the U.S, Europe, Asia, and Latin America.  PRU has three main business components; Insurance, Investment, and Foreign Insurance and Investment.  Like all other insurance companies, PRU has struggled to stay liquid as well as minimize investment losses.

PRU has gone through a number of downgrades from investors due to questions about their liquidity and ability to pay off debt.  They face a very high amount of operating debt relative to competitors, and this may force changes in the future.  Analysts believe that all of 2009 debt should be payable because Prudential paused their stock buyback plan and froze dividends.  However, this tight capital situation restricts their financial flexibility.

In addition to their capital issues, PRU faces above average risk on their variable life and annuities businesses, as well as equity markets pertaining to its asset management, both domestic and abroad.  With volatile credit and investment markets, PRU must be extremely careful moving into the future.

Prudential has taken positive strides by both increasing their foreign market exposure by injecting $400 million into Japan and buying Yamato Life units, a Japanese insurance firm that recently declared bankruptcy.  However, in a buyers market, I don’t foresee Prudential being capable of drastically improving their position relative to their competitors.  I feel that Prudential has a lot of work to do; focusing internally on their own operations, straightening out their debt obligations, and minimizing investment losses.

Travelers

Travelers (TRV) is a company that provides various commercial and personal property and casualty insurance products and services.  Their dominance of the commercial issuance market and strong financials places them above most of their peers. They have a strong financial position, courtesy of a large and strong balance sheet.   Secure financials will allow them to be an active buyer in the auctioning of AIG non-core assets which should take place in the near future.

TRV is especially solid in sales because of their diversified revenue stream.  Their marketing of numerous products as well as a strong based business insurance model will allow them strong growth in the future.  They recently released a new model, CustomComps, which offers large businesses more options in choosing packages for their convenience.  It is in these markets that TRV will continue to thrive and flourish in the future.

This past year, TRV posted a net income of $2.9 billion, which despite a decline, is encouraging  considering the hurricane losses in the third quarter.  They posted a very respectable return on equity of 12.8%. This solid year, despite facing natural disasters and financial crisis, speaks volumes about the management which has reaffirmed that they expect returns on equities to stay in the mid-teens.

In addition to their operating model, their investment portfolio has been one of a conservative nature.  They have completely avoided CDO’s and other security and credit swaps.  This will prove a tremendous asset in the future, as insurance companies are primarily judged now on their investment portfolios’ stability.  Staying clear of these credit issues will allow TRV to focus on the basics and continue to post solid returns just like in the past year.

The Future

I don’t believe that the Insurance Industry as a whole has completely reached bottom, with many companies’ investment portfolios yet to incur all the losses that are anticipated. In the near future, the industry will once again present investment opportunities once all losses have been incurred. Once the dust from AIG settles, we will be able to see more clearly how this industry will move forward, as it is still murky.

However, many companies are trading relatively cheap compared to their book value. While many are not in a solid financial position, several companies have set themselves up nicely for the long term.

MetLife has clearly positioned itself to become the winner of the insurance race in the future.  I feel that Traverlers is a close second, and has proven itself to be very stable company under quality leadership.  The next 6 months will be a slow first leg of the race, but it should turn into an all out sprint after the turn.

Disclosure: None.

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Comment by Sugato Chakravarty

2009-05-19 11:54:02

Joe: I am a finance professor at Purdue and came across your summary of the insurance industry. I have a book on personal finance and am currently revising it to update the content to make it more relevant to the current environment. In that context I came across your write up on the state of the insurance industry and would like to include it in the book (under your byline of course). There would be no money involved — just the write up will be included under your name and you will get a free copy of the book. Please let me know if it is acceptable to you. Also if you happen to be interested in graduate work after you get done with Penn State, drop me a line. Thanks. Sugato

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