We truly loved this article. The writer addresses many of the sentiments we have seen develop over the last five years. The most alarming undertone is the lack of understanding as to why the life insurance companies have had success over the last little while. A lack of understanding in any investment good or bad can put your money in jeopardy. This type of “jump on the bandwagon” investing is not just present in the insurance sector, its everywhere.
Cameron French, Reuters
7:40 AM, E.T. | March 26, 2012
After steep losses in 2011, life insurers are suddenly among the hottest plays on the Canadian market, though the stocks may have trouble building on their gains given a murky profit outlook and recent changes in their business mix, analysts tell Reuters.
With a 13-percent rise over the past two weeks, Industrial Alliance (IAG-T 31.01 -0.09 -0.29%) leads a group that has been hit hard since the financial crisis in 2008.
The group was caught flat-footed by the stock market plunge in 2008, which caused losses on their guaranteed investment products. Since then, volatile stocks and falling bond yields have forced them to take charges to guarantee future obligations, further hitting their share prices.
A recent rise in bond yields - spurred by a market-friendly comments from the U.S. Federal Reserve this month and healthier U.S. economic data - has brought back investors eager to catch a recovering sector on the upswing.
But analysts caution that while the rise in bond yields is definitely a positive for the companies, it's too early to say they're out of the woods.
"If you buy a lifeco right now, you're making a leveraged bet that the 10-year and 30-year bond yields will tick up. That's all it is," said Peter Routledge, an analyst at National Bank Financial. "Nothing has changed over the last two weeks in terms of earnings outlook."
MARKET-RELATED LOSSES
In addition to Industrial Alliance, Manulife Financial (MFC-T 13.76 -0.2 -1.43%), Sun Life Financial (SLF-T 24.05 -0.05 -0.21%) and Great-West Lifeco (GWO-T 24.57 -0.11 -0.45%) have risen 11 percent, 12 percent and 4 percent, respectively, versus a flat performance of the benchmark S&P/TSX composite index.
Under Canadian accounting rules, life insurers must keep adjusting their projections of returns from the huge investment portfolios that back their policy obligations.
Canadian government bond yields recently hit a 2012 high, with yield on the 30-year issue rising to 2.836 percent from a record low 2.413 percent in December.
When lower stocks or bond yields reduce return projections, the insurers must take the difference out of their profits, which has led to steep quarterly losses during quarters when markets are weak.
While the companies take losses when yields fall, a flat to slightly higher market does not mean easy sailing, analysts note.
Indeed, if rates stay at their current level for the long term, the insurers would have to take more losses on longer-term obligations, meaning that rising yields are needed just to preserve the status quo.
To get to the point of a meaningful improvement in earnings expectations, a more substantial and lasting move is needed.
RBC Capital Markets analyst Andre-Philippe Hardy said interest rates need to rise 50 basis points and stock markets have to rise 8 percent in each of the next two years for the companies to meet return-on-equity estimates of 10 to 12 percent.
Over the last 10 years the market has rarely had a consistent rally that would equate to an 8 percent per year return. If the insurance industry can’t keep up with that pace, what will it mean to those profits? It seems like a rally on a specific sector just because there was a shift in sentiment. This isn’t new.
"We would not chase this rally," he said in a note, adding that he does not expect the recent market moves to have a meaningful impact on first-quarter results.
DOUBLE-EDGED SWORD
The lack of positive profit impact from the market move is largely the result of the insurers' efforts over the past two years to waterproof their results against market volatility.
Both Manulife and Sun Life have heavily hedged against both stock and bond movements and cut out products that exposed them to losses in weak markets.
This has reduced negative earnings shocks over the last year, but also means there will be less of a positive impact as markets rebound from current levels.
A lot of the profits that they were booking ... they didn't have the hedging costs built in," said David Beattie, an analyst at Moody's Investors Service. "So it's really just a question of how they regain their profitability given the constraints around the product offerings they have now."
Despite their caution, analysts agree the life insurers are priced well below what the health of their core businesses would otherwise suggest, and at current prices, the group offers compelling dividend yields.
But they also warn the recent shift in bond yields could quite easily reverse itself, meaning a wait-and-see approach is the right strategy.
"The problem is if the U.S. economy hiccups again, or something happens unexpectedly with China, or something happens with Europe, you'll have a flight back into U.S. Treasuries, and down go yields," Routledge said.
"You buy a certain amount of systemic risk totally unrelated to the business franchises that these companies have when you buy a lifeco."
In my time in the financial industry I have never seen a market so impacted by Geo-Political events. A nuclear threat in Iran, Greek Bailout, Oil Futures, and a US election to boot. Our world has become so interconnected that when one invests, they can no longer just look at a P/E ratio or a trend-line. The macro events of our world will impact the performance of even the best equity based portfolio.
Lenny Kerman is the EVP of Operations for Altaview Financial Group. Altaview’s primary concern is to provide our clients with true diversification, to lower volatility while increasing returns. Please feel free to contact us for a free consultation.
