2. 2
S&P Capital IQ Equity Research
European Insurers
Contents
1. Executive Summary 3
2. Sector Overview 4
Sector Stance - Overweight 4
Share Price performance 5
3. The Great Normalisation 7
Interest Rates 7
Equity Markets 11
4. Operational Outlook 14
Geographic Exposure & Product Mix 14
Life versus Non-Life 16
5. Regulatory Issues 22
Solvency 22
G-SIIs 24
6. Valuation 27
Risks 32
Glossary 33
Appendix 36
Company Section 37
Aegon NV 37
Allianz 39
Aviva Plc 41
Axa 43
Generali 45
ING Groep 47
KBC 49
Legal & General Group Plc 51
Munich Re 53
Old Mutual PLC 55
Prudential Plc 57
Sampo 59
Standard Life 61
Swiss Re 63
Zurich Insurance Group 65
S&P Capital IQ 67
Disclosures/Disclaimers 69
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European Insurers
1. Executive Summary
The Great Normalisation
Our positive strategic view provides encouraging macro tailwinds for the sector.
Rising equity markets are beneficial to insurance companies on several fronts, life
companies in particular. A steepening yield curve, despite the initial impact of
falling asset values, is also a major positive, again for life companies in
particular, though as we discuss, the initial accounting impacts can be
counterintuitive.
More positive on Europe
We are becoming more positive on European markets, where we have seen signs
of recovery, following weakness in Europe (France, Spain and Italy in particular).
Improving, or stabilising, economic fundamentals should help both life and non-
life businesses. Nonetheless, we continue to like Far Eastern exposure, given the
attractive product mix and the medium term secular growth story. There could be
some short-term translational FX weakness in Q3, we think.
Increasing preference for Life exposure
We are seeing signs of recovery in life markets, initially in the US and now
increasingly in Europe. Indeed, FY13 life consensus forecasts have been rising
ahead of other subsectors. Savings rates in European countries have fallen from
relatively high levels, and should now stabilise, in our view. Profitability should
benefit from rising long rates. Nonlife divisions, in contrast, remain pressured by
short-term rates and we think the top-line outlook is limited to GDP growth at
best.
Capital risks from Solvency 2 and G-SIIs
Sector capital ratios are generally robust, in our view, with coverage ratios of, on
average, 2 times or above in our universe, and most companies seem prepared
for Solvency II implementation, though this has been pushed back to 2016. We
expect a relatively benign outcome from Solvency II. We are more concerned on
the potential impact of five companies under our coverage being designated as
Globally Systemically Important Insurers (G-SIIs)
Valuation
Sector valuations are not demanding, in our view, with an implied cost of equity
of around 11%. On Embedded Value metrics, which we believe offer more
realistic measure of value, the sector is trading on 2014E Price/EV of 1.07x, for an
expected 2014E Return on Embedded Value (RoEV) of 13.1%. The 2013E average
dividend yield for our universe of c. 3.8% looks secure for most companies, we
believe. We see further scope for positive earnings surprises on higher
investment returns, and valuation improvements from further equity premium
contraction as the economic environment improves.
4. 4
S&P Capital IQ Equity Research
European Insurers
2. Sector Overview
Sector Stance - Overweight
We are Overweight on the European Insurance sector, with our positive strategic
stance on equities suggesting favourable tailwinds for the sector. With a sector
beta of around 1.2x, the sector has historically been geared to equity markets.
Fundamentally, the Insurance sector benefits from higher equity markets on
several fronts: rising shareholders' funds, higher fees from Assets under
Management, higher share of participating products (e.g. With-Profits), and
improving consumer sentiment and life sales. Higher markets and investment
yields can also relieve the pressure from guarantees in some product lines.
Driving our positive view of equity markets is our expectation of economic
recovery both in the US and Europe. This increases the probability of a sustained
steepening of the yield curve, in our view. Although European central banks have
publicly committed to keeping rates low, long-term rates have been rising both in
Europe and the US. A rising yield curve should benefit insurance companies at an
economic level through higher investment income. However, there can be
accounting noise, as substantial fixed income holdings (c. 70% of investments for
sector coverage) decrease in value, having a leveraged impact on IFRS NAVs
(IFRS liabilities are discounted at a predetermined rate). The impact on Embedded
Values is generally positive, with higher assumed returns usually offsetting a
higher discount rate (depending on product mix). The impact on Solvency ratios
is mixed.
Life sales and profitability have been poor in Europe but we see signs of a
potential recovery. Savings rates have fallen from relatively high levels (versus
the US) and should stabilise as economic conditions improve, boosting sales of
life savings products. The medium term case for higher retirement savings in
mature markets is a compelling one, and profitability could remain under
pressure, but rising long rates should gradually provide respite. Property &
Casualty pricing is on an upward trend in the US, but mixed in Europe. Most
European companies expect P&C growth in line with GDP, but in many cases
have good exposure to the US and increasingly emerging markets. Asset
management divisions should benefit from improving equity markets, both
through higher fees and inflows. Fixed income managers (e.g. Pimco, part of
Allianz), which generally operate with lower margins, could suffer from further
outflows and lower market values.
Valuations are undemanding, in our view, and our target prices imply an average
12-month total return of c. 5%. Further equity risk premium compression, as
economic fundamentals improve, and increasing investment returns could
provide positive share price catalysts. Our coverage universe 2014E dividend
yield of 4.3% looks secure, in our view, given forecast payout ratios and capital
levels. There remains uncertainty around Solvency II, which has now been
delayed again to 2016, but overall capital levels1
are robust, we believe, at around
210% for our coverage universe. Five companies in our coverage universe have
been designated as Globally Systematically Important Insurers (G-SIIs), the
1
Current Solvency 1 ratios
We are Overweight, consistent with our
positive strategic view on equities.
Rising interest rates can cause short term
accounting noise, but ultimately improve
investment returns
Savings rates have fallen from relatively
high levels in non-Anglo-Saxon economies
and should stabilise
Sector valuations are undemanding…
… but there are regulatory uncertainties
5. 5
S&P Capital IQ Equity Research
European Insurers
implications of which are unclear at this stage, but we think likely to be negative
for the companies concerned.
Share Price performance
Chart 2.1 shows the performance of the S&P 350 Insurance sector versus the S&P
350 and S&P 350 Banks index over the past 12 months. Both subsectors have
outperformed by a broadly similar degree (circa 14% on a Price Return basis).
The insurance sector benefitted from sound results in FY 12 and Q1 13, which on
balance met expectations, set against undemanding valuations. Q2 2013 results
were a little more mixed, as the impact of rising rates began to impact IFRS
NAVs, hence boosting the P/Book valuations of the sector by about 10-20%.
Although we think the impact of this dynamic alone on insurer balance sheets
should be immaterial to valuations (rising rates are in fact a positive for the
sector, and have little impact on economic solvency measures – see Section 3),
we think there was an impact on investor sentiment.
Thematic Sector Outlook
Chart 2.2 on the following page explores some of the key themes in the sector,
and gives our qualitative assessment of whether these dynamics are a positive or
a negative for each company. A dark blue square indicates a strong positive for a
company/theme, a strong red a negative, and white denotes either a neutral or
not applicable theme for that company. For each theme we indicate whether it
reflects our central outlook for the sector, or more of a risk. Given the diverse
business and geographical mix of the European insurance sector (incorporating
global life/non-life insurance, asset management and banking) we hope this chart
provides an intuitive guide to the key themes and their potential impact across
the sector.
Chart 2.1: Financials sector share price performance versus S&P 350 Europe
‐5.00%
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
40.00%
S&P EUROPE 350 - Insurance S&P EUROPE 350 - Banks
S&P EUROPE 350
Source : Company data, Capital IQ. Oct. 2013.
The S&P 350 Insurance sector has
outperformed the S&P 350 by c. 14%
over the past 12 months
Sound FY12 and Q1 13 results supported
share prices, but Q2 13 was more mixed
This is intended as a guide to the key
themes in the sector and their potential
impacts on companies
6. 6
S&P Capital IQ Equity Research
European Insurers
Chart 2.2: Thematic sector guide. A dark blue square indicates a strong positive for a company/theme, a strong red a
negative, and white denotes either a neutral or not applicable theme for that company. For each theme we indicate
whether it reflects our central outlook for the sector, or more of a risk.
Source : S&P Capital IQ Equity Research. Oct. 2013
THEMERISKDETAILS
AEGON
Allianz
Aviva
AXAGroup
Generali
INGGroup
KBGroup
Legal&General
MunichRe
OldMutual
Prudential
SampoGroup
StandardLife
SwissRE
ZurichInsurance
MACROTRENDSOUTLOOK
Longinterestratescontinuerising,leadingtorisingyieldcurve,
relievingpressureonlifebooks
86667655.585.565.55.56.57.5
OUTLOOKEuropeanequitymarketstorisein2013and201475.578665.365.577.55.885.55.5
TAILRISK
ProblemsinperipheralEurozoneintensify,withpossibleexitsfrom
Euro
5332144544.554.54.543.5
OUTLOOK/RISKFallinEmergingMarketcurrenciesandGDPgrowthcontinues54.553.53.53.55542.52.5553.54
PROPERTY-CASUALTYOUTLOOKEuropeanmotorratestocontinuetorise5666.5755.55.5556555.5
RISK2013(or14)seesarepeatofheavynatcatlossesasin201134.54.5453.54.52553.5523
RISK
Short-termratesincreasefasterthanexpectedboostingP&C
incomebeforepricepressure
57.577755.56.57556.5577
LIFEINSURANCEOUTLOOKImpactofRDRcontinuesinUKandsimilartrendsinEurope4.5445.86.5567.557.5658.555
OUTLOOK/RISK
Continuedpressureoninvestmentincome(rates,derisking)impacts
lifeprofitabilityandreserving
22.54425553554.552.52.5
MostlyRISKIncreasedcompetitioninunit-linkedspaceimpactmargins/volumes4544354.54544.55344.5
ASSETMGMTOUTLOOKPositiveequitymarketstodriveassetmanagementretailinflows65.25.57.56.55.557576.56855
BANKINGOUTLOOK
ImprovingmacrotrendstodriveFees/CommissionsandlowerLoan
LossProvisions
5555.55.588557.557.55.555
RISK
Risinginterestratesleadtoincreasingdefaultsonmortgagebooks
(impacteitherdirectorindirect)
5554.5522.53.5554.54555
CAPITAL/REGULATORYOUTLOOK
RisinglongratestoimpactIFRSNAVs(economicallythisis
relativelyunimportant)
2.55.52.54.534.24.25.31.552.254.82.73
RISK
Solvency2refusestorecognise‘illiquidity’premiumforliability
reserving
4.5534.555533.553.354.844
RISK
DesignationasaGloballySystematicallyImportantInsurer(G-SII)
imposesexcessiveconstraints.
53.53.53.53.5555553.55555
COMPANY
7. 7
S&P Capital IQ Equity Research
European Insurers
3. The Great Normalisation
Interest Rates
Chart 3.1 EU and US 10-year rates vs. S&P Europe 350 Insurance
Source : S&P Capital IQ, Bloomberg. Oct 2013
Chart 3.1 illustrates the close correlation between insurance sector relative
outperformance and 10 year bond yields. The more simplistic Chart 3.2b perhaps
suggests that markets have already anticipated rising rates, but from such low
levels we think there is still scope for further sector outperformance, as
suggested in Chart 3.1. 10 year bond yield percentage change is at a 10 year high
following the recent spike. Driving this behaviour are the substantial investment
returns on fixed income portfolios. As illustrated in Chart 3.2a, the industry is a
major holder of fixed income assets, in particular government bonds, though
allocation to corporate bonds is increasing as companies search for improved
yields. With rates at very low levels, companies’ book values are benefitting from
significant unrealised gains1
. Rising rates are likely to significantly impact IFRS
book values, as liabilities are usually discounted at a predetermined fixed rate.
From an economic, and asset-liability matching, perspective (ALM), we do not
view this as of much relevance to company valuations2
. Companies publish a
wide range of sensitivities of various metrics to shifts in macroeconomic factors.
Disclosure here is mostly at the discretion of the company, and difficult to
aggregate into one table. We have collated interest rate sensitivities across our
1
These are often referred to as ‘revaluation reserves’
2
Provided the company has either cash flow or duration matched effectively, asset defaults are not above average,
and liabilities emerge as expected the insurer should be able to meet its obligations regardless of fluctuations in
unrealised fixed income portfolios. Considered from another perspective, a lower NAV and higher ROE from higher
investment income should lead to a higher justified P/NAV.
Chart 3.2a: Sector coverage 2012
asset mix, including unit-linked
funds
Fixed
Income
Equitie
s
Real
Estate
Cash
Loans
Alterna
tives
Uunit-
Linked
Other
Source: Company Reports, S&P Capital IQ Equity
Research. Oct 2013
Chart 3.2b: Sector performance
versus 10yr yields
0
50
100
150
200
250
300
EU 10Y
S&P 350 Insurance
UK 10Y
Source: S&P Capital IQ, Oct 2013
8. 8
S&P Capital IQ Equity Research
European Insurers
coverage universe and present the key impact of increasing rates below in Chart
3.3:
Chart 3.3: Disclosed company sensitivities to changes in interest rates. Profit metrics are coloured red, IFRS balance
sheet blue, Solvency black and Embedded Value related metrics orange.
-16.7%
5.5%
3.6%
10.5%
10.5%
-6.4%
-37.9%
-0.2%
3.0%
-3.0%
5.5%
-4.1%
-1.4%
-5.6%
0.7%
5.8%
-2.6%
-0.2%
-21.5%
-12.7%
6.1%
-2.0%
-8.6%
-15.4%
-27.8%
-3.0%
5.8%
-1.3%
10.1%
-17.5%
0.8%
-17.1%
-17.5%
-15.1%
4.0%
20.0%
-50% -40% -30% -20% -10% 0% 10% 20% 30%
Aegon + 100bps on Equity
Aegon + 100bps on Net Income
Allianz + 100bps on Net Income
Allianz + 100bps on Solvency Ratio
Allianz + 100bps on EV
Aviva + 100bps on Equity
Aviva + 100bps on Profits
Aviva + 100bps on EV
Axa + 100bps on EV
Generali + 100bps on Equity
Generali + 100bps on EV
ING Group + 100bps on Equity
KBC + 100bps on Equity
KBC + 100bps on Net Income
Legal & General + 100bps on Equity (net of reinsurance)
Legal & General + 100bps on PTP (long-term business)
Legal & General + 100bps on EV
Legal & General + 100bps on New Business
Munich Re** + 100bps on Equity
Munich Re + 100bps on Profits
Munich Re + 100bps on EV
Old Mutual + 100bps on Equity
Old Mutual + 100bps on EV
Old Mutual + 100bps on New Business
Prudential + 100bps on Equity
Prudential + 100bps on Net Income
Prudential + 100bps on EV
Prudential + 100bps on New Business
Sampo Group + 100bps on Equity
Sampo Group + 100bps on Solvency Capital
Standard life + 100bps on Equity
Standard life + 100bps on EV
Standard life + 100bps on New Business
Swiss Re + 100bps on Equity
ZIG + 100bps on Equity
ZIG + 100bps on EV
ZIG + 100bps on New Business
Source : S&P Capital IQ Equity Research. Company Report & Accounts. All disclosures are from 2012 company report and accounts, and therefore may not apply to future
results. Oct 2013.
Munich Re numbers gross and before tax and policyholder participation in surplus. Most sensitivities are calculated before taxes and include the effects of derivative positions.
9. 9
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European Insurers
A mixed picture despite positive economics
The interaction between financial markets – interest rates in particular – and an
insurance company is somewhat complex, and varies from company to company,
depending on business mix, asset allocation, classification of assets, the presence
of guarantees, hedging and so on. This is reflected in Chart 3.3 above, which
shows company disclosure for the impact of rising rates (mostly a 100bps
increase) on various company metrics. For all of these, this impact is considered
in isolation of other possible factors (e.g. equity markets, volatility, mortality),
which in practice may be correlated with interest rate moves themselves.
Sensitivities are also not necessarily linear, nor symmetrical, and larger or
smaller impacts should not be interpolated or extrapolated from the results.
Similarly, these results do not factor in the potential for management
intervention.
It seems logical that rising interest rates are a positive for the sector, as they
drive higher returns on invested premiums. However, different accounting
methods (e.g. IFRS, US GAAP and Embedded Value) can initially appear to
complicate the issue further, although analysis of these and their differences can
provide some valuable insights.
Below we make some observations on the disclosed sensitivities in Chart 3.3:
Positive impact on Embedded Values in most cases
This sector specific valuation/solvency metric is applied
somewhat inconsistently across the sector, but we believe
provides valuable information about companies’ economic
sensitivities. Notably it has a more realistic approach to balance
sheets, discounting liabilities at the appropriate rate (usually a
swap curve) and hence avoiding some of the IFRS NAV
volatility.
Higher interest rates usually result in a higher discount rate
being applied to the projected profits stream, and for streams of
underwriting profit this will mean a lower EV. They also usually
mean higher assumed investment returns, which for spread
business, where the insurer aims to earn an investment return
above the guaranteed policyholder rate, should result in higher
projected profits, particularly if current interest rates are low.
Generally speaking, a rise in interest rates should improve
Embedded Values, with the major European names (Munich Re,
Generali, Allianz and Axa) the most sensitive, we believe, the
first two due to Life spread risk products with guarantees.
Downside risks (decrease in rates) for companies such as these
tend to be greater, due to the proximity of current yields to
policyholder guarantees. Prudential is relatively insensitive,
despite its UK annuity and US variable annuity book. Legal &
General reports a negative impact to EV. There is no easy
explanation here, with two business lines counteracting each
other. The bulk of L&G’s profits come from the ‘Protection and
Annuities’ division. Annuities should benefit from higher
assumed returns on fixed income assets, but a higher discount
rate; protection would be impacted only by a higher discount
rate on underwriting profits.
Negative accounting noise can be
misleading given the improving
fundamentals
Higher interest rates generally positive for
Embedded Values
Munich Re, Generali, Allianz and Axa
EVs most sensitive to rise in rates
10. 10
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European Insurers
The impact on IFRS NAVs is negative
The average decline in IFRS NAV for our coverage universe is
9.3%. Given IFRS liabilities are usually discounted at a
predetermined rate, and non held-to-maturity (usually the
majority) fixed income assets marked at fair value in equity,
rising rates decrease IFRS shareholder’s equity and vice-versa,
though the impact is not symmetrical1
.
Munich Re stands out as particularly sensitive, with a 21.5%
decrease in NAV for a 100bps rise in rates (parallel across the
yield curve), and 23.6% rise for a 100bps decline. This
sensitivity was borne out at the H1 13 results. KBC, Sampo, and
Standard Life stand out as relatively insensitive. Aviva,
Generali, and L&G are surprisingly insensitive given their high
levels of fixed income holdings versus NAV (see Appendix). We
think this reflects absorption of the impact in the liabilities by
policyholders, and the classification of fixed income holdings in
assets.
Impact on profits can be counterintuitive
Changes in interest rates, and hence the value of fixed income
investments, should have relatively little impact on profits, as
most of the changes in value should pass straight through to
equity2
. Sometimes, investments (held-to-maturity) are
measured and valued at amortised cost and so there is no
impact on changes in capital value either. Nonetheless Munich
Re indicates a 13% fall in NI given a 100bps rise in rates.
Aviva’s, for one-off accounting reasons, reports all unrealised
losses in both the income statement and in equity, which leads
to a misleadingly high fall in profits. KBC, which is
predominantly a bank, also suggested a decline. Given the very
high exposure to fixed income portfolios, even a small
proportion of unrealised losses passing through the income
statement impacts profits.
For non-EV metrics, these sensitivities depict the immediate
impact of rising rates. Investment yields can take time to
improve with increasing rates, as securities mature and are
replaced. This dynamic does not appear to be reflected in the
sensitivities reported here. In contrast EV measures account for
higher reinvestment rates in the future, and as such are a more
realistic guide.
We present only the impact of rising rates; the economic impact of interest rate
movements is often asymmetrical, due to the effect of policyholder guarantees3
,
at least where these are accounted for properly in either the TVOG (Time Value of
Options and Guarantees) in Embedded Value accounting, or in actuarial reserve
calculations under IFRS. Thus decreasing interest rates can have more of an
1
Amongst other things, this likely reflects the convexity, yield and duration of the fixed income portfolio
2
The majority of our coverage universe assets are held as AFS (Available for Sale), an accounting classification. They
are held at fair value on the balance sheet, with unrealised gains and losses flowing straight to equity (through
comprehensive but not standard income)
3
An example of this in the UK would be With-Profits funds
Higher rates negatively impact IFRS book
values due to liabilities being discounted
at predetermined rate.
Depending on classification of assets,
rising rates can negatively impact profits
in the short term
Non EV sensitivities fail to capture the
potential for higher investment income in
the future
11. 11
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European Insurers
(economic) impact than increasing interest rates, particularly when investment
yields are close to guaranteed rates.
Low interest rates – relief could be slow to materialise
Although global interest rates have been low since 2009, the incrementally
negative impact on life insurance has continued. Indeed, this is a message
frequently repeated by almost all company managements in 2013. Due to
imperfect asset-liability matching (ALM; liabilities often longer than available
assets), life insurers are forced to reinvest at lower rates. For longer term lines of
business (e.g. Life), aggregate yields could be slow to improve, but where
liabilities are accounted for on an economic basis (e.g. EV accounting, Solvency)
benefits could be more immediate.
The existence of guarantees (which can be considered equivalent to being short
of put options) complicates the situation, particularly if the reinvestment rate, and
eventually the aggregate rate, falls below guaranteed rates. Those companies
with German and Italian life exposure, such as Allianz, Zurich Insurance Group,
Munich Re and Generali, are particularly exposed to European spread products
with guarantees. In the US, Aegon, Axa, Prudential all have exposure to
guaranteed life products. Embedded Value metrics capture the improvement of
higher rates more effectively, though, with projected higher reinvestment rates
impacting the Embedded Value immediately.
Equity Markets
A slightly more consistent picture
Rising equity markets are almost always positive for insurance companies,
driving the balance sheet, revenues and profits on different fronts:
Shareholders’ Funds: Although many have substantially de-risked since
the early 2000s, insurance companies do hold some equities in
shareholders’ funds.
Participating funds: These are products where the investment return is
shared between policyholder and insurance company. In the UK this
might be with-profits funds, in Europe endowments.
Unit-linked AUM: These are products which are on the insurance
company’s balance sheet, but with an offsetting liability. The
policyholders bear all of the investment risk, though the insurer benefits
from higher AUM through higher fee income.
3rd
party AUM: These are equities held for 3rd
parties (sometimes also
within the group company). As for unit-linked funds shareholders benefit
from higher AUM and fees, but the 3rd
party bears all of the investment
risk.
The achieved investment return of
insurers will continue to decline if rates
remain low.
Life sector can be slow to respond to
improving economic backdrop
Equity markets impact insurers on several
different fronts
12. 12
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European Insurers
Chart 3.4 details explicit guidance on sensitivities provided by companies.
Chart 3.4: Company explicit equity market sensitivity disclosures.
-2.5%
0.0%
1.8%
3.0%
5.2%
1.0%
2.8%
2.8%
0.5%
-1.4%
3.7%
-3.5% -2.5% -1.5% -0.5% 0.5% 1.5% 2.5% 3.5% 4.5% 5.5% 6.5%
Aegon +10% Equity markets on Net Income
Aegon +10% Equity markets on Equity
Aviva +10% Equity markets on Equity
Aviva +10% Equity markets on EV
Generali +10% Equity markets on Equity
KBC +10% Equity markets on Equity *
Legal & General +10% Equity markets on EV
Munich Re +10% Equity markets on Equity
Prudential +10% Equity markets on Equity
Sampo Group +10% Equity markets on Equity
Standard Life +10% Equity markets on Embedded…
Source : S&P Capital IQ, 2012 Company Report & Accounts. * indicates S&P Capital IQ Equity Research estimates. Profit
metrics are coloured red, IFRS balance sheet blue, Solvency black and Embedded Value related metrics orange. Oct 2013
Disclosure for rising markets is relatively thin, focusing more on downside risk,
and the impacts modest. Again, as for the interest rate sensitivities, these
sensitivities consider the impact of equity market moves in isolation on current
(non 3rd
party) holdings and books of business. They do not (appear to) consider
the impact on revenues and hence profits from higher 3rd
party AUM, with
Embedded Value accounting usually restricted to traditional life insurance
business. This might explain Prudential’s relatively low sensitivity, despite its
very high balance sheet exposure to equities (see Chart 3.5). We would make a
couple of observations:
Higher equity markets are almost always a positive for
Embedded Values as equity assets are marked to market and fee
income streams are projected off a higher base. Higher equity
holdings may be offset by higher liabilities in the case of
product lines where the policyholder bears some or all of the
risk, but – hedging aside - there are none of the asset-liability
complications found in interest rate sensitivities.
The impact of higher equity markets is generally positive but
sometimes complicated by the existence of hedging. In Aegon’s
case a 10% rise in equity markets leads to a slight decline in
equity, and 2.5% decline in net income, due to the impact of its
extensive US Variable Annuity hedging1
. The impact of hedging
can be further complicated by policyholder participation and tax
effects.
As for interest rates movements, the impact of equity market movements can be
asymmetrical, due to the effect of policyholder guarantees, at least where these
are accounted for properly in either the TVOG (Time Value of Options and
Guarantees) in Embedded Value accounting, or in actuarial reserve calculations
under IFRS. An example of this in the UK would be With-Profits funds (WP),
where the ‘bonuses’ credited to policyholders in effect become guarantees which
1
Movements in derivative hedges are included in income, but not always (if AFS) the movement in
the underlying assets.
Higher equity markets a positive for
NAVs, EVs and profits…
…unless there is extensive hedging in
place, as in the case of Aegon
Higher equity markets almost always
positive for Embedded Values
Hedging arrangements can complicate
analysis
13. 13
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European Insurers
can be considered as ‘short puts’ from the insurance company’s perspective. The
UK names with WP funds – Legal & General, Aviva and Prudential – typically
have surplus capital in the WP funds, which can be distributed to policyholders
(usually 90%) and shareholders (usually 10%).
A balance sheet leverage perspective
Chart 3.5 provides a somewhat crude guide of company exposure to equity
markets. Where the information is available, we have tried to break down equity
holdings into the degree of shareholder versus policyholder participation in asset
risk. In unit-linked categories policyholders bear all of the risk (though insurers
benefit from higher markets through higher fee commission). For participating
funds, investment risk is shared between policyholder and shareholders, often
according to local regulations. As discussed, these often contain guarantees and
so increase downside risks for shareholders. For non-linked we assume that
shareholders bear the risk. For quite a lot of equity holdings, i) it is not clear how
to categorise holdings, ii) there is no adjustment for hedging (extensive in US VA
books for Axa, Prudential and Aegon) and iii) available data does not always
account for tax implications and/of policyholder participation. Thus this analysis
should only be considered as part of a more general sensitivity analysis, taking
other intuitive or qualitative factors into consideration.
However, we can make a number of observations. Perhaps unsurprisingly, the
Life names (see chart 4.3) appear to be the most exposed. Legal & General
stands out with its very high ratio of unit-linked funds to shareholders funds. This
is a result of its large index tracking funds, which although substantial in size
relative to L&G, are very low margin. Prudential, Axa, and Aviva also stand out
for high exposure through linked funds. Aviva and L&G’s high proportion
classified as participating reflects the large with-profits funds. Prudential’s high
exposure to unit-linked funds suggests high shareholder equity exposure, in our
view. The predominantly non-life insurers – Allianz, Sampo, Swiss Re, Zurich
Insurance – have significantly less exposure. The banks and reinsurers – KBC,
Munich Re, Swiss Re – have very little exposure.
Chart 3.5: Coverage universe equity holdings as a % of shareholder’s equity (excludes 3rd
party assets)
0%
50%
100%
150%
200%
250%
300%
350%
400%
Aegon Allianz Aviva Axa
Genera
li
ING
Group
KBC
Legal
&
Genera
l
Munic
h Re
Old
Mutual
Pruden
tial
Sampo
Group
Standa
rd life
Swiss
Re
ZIG
Equities - Unspecified/SH 6% -1% 1% 37% 4% 0% 16% 0% 0% 233% 1% 29% 701% 21% 40%
Equities - Asset mgmt 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%
Equities - Unit-Linked 0% 0% 233% 241% 81% 172% 0% 2730% 0% 0% 767% 39% 0% 0% 0%
Equities - Non-linked 0% 23% 14% 0% 0% 0% 0% 22% 0% 0% 10% 0% 0% 0% 0%
Equities - Participating 155% 40% 101% 0% 0% 0% 0% 76% 0% 0% 261% 0% 0% 0% 0%
Source: S&P Capital IQ Equity Research estimates, 2012 Company Report & Accounts. Participating funds (e.g. With-Profits) include both shareholder and policyholder share. Oct. 2013.
Balance sheet approach has limitations
around policyholder participation, tax,
and hedging programmes
Unsurprisingly, the Life names have the
highest equity exposure
14. 14
S&P Capital IQ Equity Research
European Insurers
4. Operational Outlook
Geographic Exposure & Product
Mix
Globalised Industry
Chart 4.1 shows the aggregated breakdown in sector premium/revenues written
by region. Like other industries, insurers are keen to expand into the faster
growing regions mostly in Asia, where insurance penetration is still low and
economic growth remains higher. For instance, Swiss Re has a 2015 target of 20-
25% of revenues from high growth markets. Although these markets often have a
more attractive product mix (more higher-margin Health and Protection
products), we are becoming more positive on the UK and Europe, particular in
Life, which is more cyclical. We expect sales to recover following declines since
2008, whereas in Asia we see both GDP growth and currency weakness. That said,
the investment case for companies such as Prudential remains compelling on a
long term view. We expect non-life and reinsurance growth to be more tied to
GDP growth, and insurance penetration levels, and hence prefer exposure to
higher growth regions for the reinsurers and P&C focused stocks.
Chart 4.2 shows a revenue/premium breakdown for each company by region. The
‘Other’ segments often refer to asset management divisions, which, perhaps as a
result of their global nature, do not report geographical segmentation. These
segments are also somewhat underrepresented as life sales products inflows are
recorded as revenues in their entirety, whereas only the fees from inflows into
asset management divisions are recorded as revenue (and assets do not appear
on the insurer’s balance sheet). We think Axa has an attractive geographic mix in
current market conditions, with market leading positions in Europe, where we are
becoming more positive, and also decent exposure to the US and Asia-Pacific.
Chart 4.1: Geographic Coverage mix
by Revenue/Premium
Source: Company Report & Accounts 2012. Note UK
and Asia-Pacific are probably under represented as
sometimes disclosed in Europe and Higher Growth
respectively.
Chart 4.2: Coverage universe geographical breakdown of 2012 revenues (mostly Gross Written Premiums)
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Other
Asia-Pacific
Higher growth
North Americas
UK
Europe
Source: S&P Capital IQ Equity Research estimates, Company Report & Accounts. Note excludes consolidation and holding effects (usually negative). These breakdowns are somewhat
impacted by the differing treatment of savings products, where mutual fund style inflows are treated in their entirety, whereas asset managers only treat management fees as revenues. Oct
2013
15. 15
S&P Capital IQ Equity Research
European Insurers
Munich Re has a similarly attractive exposure. Generali and Legal & General,
stand out for their high exposure to Europe and UK respectively, although the
global reach of L&G’s asset management division is understated. Allianz has
good exposure to higher growth markets, but this mix does not reflect the high
proportion of profits (around a third) from Pimco, the US fixed income manager.
Life Regional differences
Different products are sold in different regions. Perhaps the most important
difference is the prevalence of health & protection products in the Asia-Pacific
region. This reflects a relative absence of state healthcare provision. These
products tend to be highly profitable relative to developed market savings-
oriented products, as reflected in the short payback periods and high IRRs. They
are also much less exposed to non-diversifiable market risk, and as such are more
akin to P&C technical profits (excluding the returns on invested premiums).
Prudential has a very high exposure to these attractive markets and product
lines. In contrast, savings products in developed markets can have unattractive
return profiles, although the size of the retirement and savings market – given
demographic trends – is substantial. We think companies such as Standard Life
are well positioned to adapt to a larger scale, less differentiated, and less
intermediated market place.
Table 4.1: Life products by region
Region Typical product range
UK With-Profits, Annuities, Unit-Linked, Protection, some health
France Increasingly unit-linked, Traditional life
German-speaking Mostly traditional life (including guarantees)
Italy Increasingly unit-linked style
US US Variable Annuities (VAs), virtually no traditional life
Asia-Pacific Health & Protection, pensions, With-Profits
Latin-America Unit-linked. Health & Protection.
Source : Company data, S&P Capital IQ Equity Research. Oct 2013
Nonlife regional differences
We think the differences in P&C insurance product mix are less pronounced than
in Life insurance, with catastrophe insurance a broadly similar activity worldwide.
More generally, the shorter tail nature of liabilities in P&C means that regulatory
and legal differences can fade more quickly1
.
The US is often viewed as a fragmented market, due to state-by-state regulation.
Litigation risk can often be higher in the US than in Europe. Admiral Group (not
covered), the UK focused car insurer, has described the US motor market as
‘complicated’. With respect to property and catastrophe insurance in Asian and
higher growth markets, we think there are additional risks, including i)
undeveloped regulatory regimes ii) more limited data available for both climate
and insured loss modelling. This potentially impacts Swiss Re, which has a 2015
target to generate 25% of revenues from higher growth markets. Old Mutual has
a consumer P&C operation in South Africa, Mutual & Federal, but this is small
and well developed. Old Mutual is, however, expanding into new markets in
Africa, both in life and non-life.
1
Asbestos liabilities in the US, which caused significant losses at RSA Group, are a notable exception
Despite some signs of slower growth in
the Far East, structural attractions of
South-eastern Asian life markets remain
Broad mix of products in different
regions, reflecting regulatory and cultural
history
Property & Casualty regional differences
less pronounced, in our view
16. 16
S&P Capital IQ Equity Research
European Insurers
Business mix differences
Chart 4.3: Coverage universe business mix breakdown of 2012 revenues (mostly Gross Written Premiums)
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Bancassurance
Banking
Asset
Both
NonLIfe
Life
Source: S&P Capital IQ Equity Research estimates, Company Report & Accounts. Oct 2013. Note Asset management divisions are somewhat underrepresented in this analysis, as life sales
products inflows are recorded as revenues in their entirety, whereas only the fees from inflows into asset management divisions are recorded as revenue (and do not appear on the insurer’s
balance sheet). Similarly, life divisions are somewhat overstated versus other divisions given the often very thin margins on savings booked as revenues.
Chart 4.3 shows the different business mix of our coverage universe. It can be
useful to compare the company business mixes here with our analysis of asset
mix and balance sheet leverage in Section 4. The Life names have a much greater
exposure to investments, directly through shareholders’ funds, and indirectly
through shareholder participation in profits and fees generated from AUM.
As in the geographical breakdown, asset management divisions are also
somewhat misrepresented as life sales products inflows are recorded as revenues
in their entirety, whereas only the fees from inflows into asset management
divisions are recorded as revenue (and do not appear on the insurer’s balance
sheet). Thus whilst Allianz’s asset management operations account for below
10% of revenues here, the division in fact accounts for around a third of operating
profits (margins of course play a part here). The reinsurers we cover do not
disclose by life versus non-life but by primary versus reinsurance, hence the
‘Both’ category in our chart. Both Swiss Re and Munich Re disclose premiums by
primary or reinsurance, and by geography, but not both.
Life versus Non-Life
We think our view of an improving macroeconomic outlook favours increasing
exposure to more cyclical life business, rather than the more defensive P&C lines.
Strong equity market performance tends to improve life sales. A steepening yield
curve improves returns which can be offered to customers, and helps drive sales.
A steepening yield curve, as we are starting to observe now, is a positive for
insurers, as insurers can offer higher long-term returns than banks offer in short-
term deposit accounts, although the customer must sacrifice some flexibility. As
explored in the previous section, life exposure fits well with our overall positive
view on equity markets, given life companies’ balance sheet exposures. Given the
Property & Casualty regional differences
less pronounced, in our view
Life sales remain mixed, particularly in
Europe, but there are signs of recovery
17. 17
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European Insurers
short duration of liabilities, we think P&C names will be slower than life names to
benefit from rising rates, another factor in relative attractions. Improving
investment returns can also lead to deteriorating underwriting and combined
ratios, as we discuss below.
Life showing signs of recovery
Following declines in life sales since 2008, driven mostly by weakness in mature
markets, H1 results showed signs of recovery, although somewhat mixed across
regions and companies. France, Italy, and Spain continued to show some
weakness, particularly in traditional savings products, but other lines, such as
unit-linked and protection, are seeing signs of growth. This reflects the shift in
product mix discussed below, as well as underlying macroeconomic trends. The
pattern across companies was somewhat mixed with Allianz, Generali and Axa
posting positive European life growth, albeit with considerable local variation, but
Munich Re and Zurich Insurance Group posting mixed or still declining sales.
Chart 4.4 shows Life FY1 earnings revisions overtaking Non-Life, though
reinsurance lines still show the highest revisions, possibly as a result of a below
average H1 2013 for losses
1
driving FY1 combined ratio estimates higher. Chart
4.5 shows life share price performance (relative to the DJ Stoxx 600) accelerating
in Q3 13. Again, the reinsurers’ performance has been quite strong.
Chart 4.4: European insurance subsector % change y-o-y FY1
EPS forecast revisions
Chart 4.5: European insurance subsector relative
performance to DJ Stoxx 600
0
10
20
30
Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13
Life rel EPS NL: Full-line rel EPS NL: P&C rel EPS
NL: Reinsurers rel EPS Non-Life rel EPS
%
-30
-20
-10
0
10
20
30
40
50
Jan-10 Sep-10 May-11 Jan-12 Sep-12 May-13
Life Rel Perf NL: Full-line Rel Perf NL: P&C Rel Perf
NL: Reinsurers Rel Perf Non-Life Rel Perf
%
Source: Bloomberg. Oct. 2013
Source: Bloomberg, Oct. 2013, Source: Insurers; Life (37%), Non-life (63%) – Full-line
(44%), P&C (7%), Reinsurers (14%)
1
Swiss Re estimates H1 2013 global insured catastrophe losses of USD 17bln, lower than the USD 21 billion in H1
2012 and also below the average of the last 10 years. This is despite significant flooding losses of USD 8bln globally,
the second most expensive on record.
A steepening yield curve particularly good
for traditional life sales.
Life consensus earnings forecasts showing
strong upwards momentum
18. 18
S&P Capital IQ Equity Research
European Insurers
Savings rates
Charts 4.6 and 4.7 show various savings trends. Although the different charts plot
slightly different metrics, we can make a number of observations:
Savings rates have been declining. This appears to be true across
mature markets, but particularly true in the US and UK, where we have
data going back further. This can seem counterintuitive, given the need
for increasing not decreasing saving for retirement. Certainly in the US
and UK, the buoyant (until 2007) property market may have affected
savings behaviour, with consumers treating equity in their homes as a
store of wealth and future pension pot.
Savings rates vary widely across regions. The ‘Anglo-Saxon’
economies fare the worst here, possibly reflecting attitudes towards
housing markets. Germany, France and Italy are known for their
relatively high savings rates.
Savings rates proved reasonably defensive in the global financial
crisis. Both charts show a spike in 2008, due to the impact of the
financial crisis on GDP and disposable income. Despite continuing their
downward trend, savings rates in the US and UK at least remain higher
than pre-crisis levels.
It is widely agreed that Western economies need to save more to reflect longer
retirements. Government initiatives, such as auto-enrolment, could help to
address this; whereas recent positive economic data in the UK is also supportive.
Standard Life, Legal & General, Prudential and to a lesser degree Aviva, are all
exposed to this trend. There are similar initiatives being rolled out in the
Netherlands, and we think that all mature markets will have to stimulate much
higher levels of retirement provision.
Chart 4.6: UK & US Personal Savings as % disposable
income
Chart 4.7: Household Gross Savings rates (%)
0
2
4
6
8
10
12
14
16
1974 1979 1984 1989 1994 1999 2004 2009
US UK
0
5
10
15
20
25
EU (27 countries) United Kingdom Germany
Spain France Italy
Netherlands
Source: Bloomberg, Eurostat, Oct. 2013 Source: Bloomberg, Eurostat, Oct. 2013
Savings rates at decade lows and
demographic trends suggest a reversal,
but exact timing is uncertain
19. 19
S&P Capital IQ Equity Research
European Insurers
Rising rates and combined ratios
Although interest rates improve investment returns, there is evidence that these
improved returns lead to more relaxed underwriting standards, increasing pricing
pressure and deteriorating (increasing) combined ratios. Thus the benefits of
higher rates do not always pass through to shareholders. Swiss Re published
chart 4.8 below, which illustrates how combined ratios have improved in a
declining yield environment. Certain years such as 2011, have not been adjusted
for high natural catastrophe losses, though the overall trend is recognisable.
From an intellectual point of view, investors should be unwilling to pay for loss-
making underwriting offset by investment returns an investor can (usually) access
directly themself, without the additional risks and costs.
Chart 4.8: Swiss Re combined ratio versus 5-year US Treasury risk-free rates.
Source : Swiss Re Presentation, Morgan Stanley Financials Conference, March 2013, Bloomberg. 2013 COR is Swiss Re
estimate. Oct 2013
Monte Carlo 2013
Although P&C insurance is often a non-discretionary spend, and hence demand
relatively inelastic, insurers do not always have strong pricing power due to
broker networks, transparent pricing, and relatively low barriers to capital flowing
into the sector. The final of these was a key theme at the Monte Carlo renewals
conference this year, in particular alternative capital such as hedge funds and
pension funds looking for returns in the low yield environment. Swiss Re
estimates that 70% of this capital focuses on US natural catastrophe risks, and
estimate the amount of worldwide alternative capacity at around USD 40bln. Both
Munich Re and Swiss Re think this trend affects smaller, less diversified
reinsurers, and that being able to deliver large scale, tailor-made solutions offers
a competitive advantage versus new entrants. Munich Re stated:
“Broadly diversified reinsurers like Munich Re offer their clients far more than
just capacity. We demonstrate this particularly in the case of complex risks such
as large industrial risks, and also in segments that are not standardised such as
liability, agricultural reinsurance or aviation”.
Although capital costs demanded by new entrants appear competitive, Munich Re
has illustrated how its superior diversification can – at group level - allow it to
match new entrants. Both Munich and Swiss Re expect broadly stable renewals in
January 2014, with some short-term weakness in natural catastrophe.
Improving investment returns can
actually be viewed as a negative for P&C
insurance
Combined ratios have improved with
declining yields
At Monte Carlo, the increasing role of
alternative capital was a key theme.
Large reinsurers were sanguine about the
threat posed to them
20. 20
S&P Capital IQ Equity Research
European Insurers
Shift away from guaranteed products
Most companies have been shifting their sales mix towards unit-linked style
products, where the policyholder bears the investment risk, away from traditional
life products which often have some form of guarantee. This reflects difficulties
many have had (e.g. Aegon, Axa, Old Mutual and Aviva all experienced material
difficulties in the US VA market) in either hedging out risk or in meeting
obligations due to volatile / declining markets and low interest rates. We view this
as somewhat backward-looking and reactionary. Many began this process with
the onset of the crisis in 2008, and are now completing the process as the
prospect of more stable market conditions (and higher rates) is emerging. This
trend also raises the question of how life insurers differentiate themselves from
mutual fund providers. This is a potential negative, but one tempered by the fact
that insurance companies are major owners of asset managers. Nonetheless,
insurance companies’ savings products are now in direct competition with
thousands of third party savings products. In the UK, the increased transparency
around charges required by the Retail Distribution Review (RDR) will add further
pressure. Similar regulatory interventions are planned in the Netherlands, and we
think that his could become a more widespread trend.
Increased platform competition
Some, Standard Life in particular, have remodelled their business as an asset
manager, with a focus on low-cost scalable infrastructure and distribution. These
platforms allow clients to manage all of their investments, regardless of fund
manager, under one platform and interface, and insurers hope that the usefulness
of these services will encourage customers to centralise their investments. There
is a charge for administering assets under the platform, regardless of the actual
investment manager and their management fees. Often providers offer discounts
on charges to encourage customers to move all of their funds to one platform. In
the case of platforms, there is competition for the underlying funds from other
asset managers, but also competition from other, possibly independent, platform
providers.
Table 4.2: Comparison of pension platform and service charges (in addition to fund
management charges)
Provider Product Service
Charge
Platform
Charge
Aviva Core Pension – Up to GBP29,999 0.35% NA
Core Pension – GBP30,000 – GBP249,999 0.30% NA
Core Pension – Above GBP250,000 0.20% NA
Fidelity SIPP – Up to GBP30,000 0.40% 0.25%
SIPP – GBP30,000 to GBP 100,000 0.30% 0.25%
SIPP - GBP100,000 to GBP500,000 0.25% 0.25%
Hargreaves
Lansdown
SIPP – 2400 funds 0% 0%
SIPP – other funds £1 - £2 per
holding
SIPP – Shares` 0.5%
Standard Life SIPP – Funds – under GBP100,000 0.6%
SIPP – Funds – GBP100,00 – 249,999 0.55%
Source : Company data. Oct 2013
We think a shift towards non-guaranteed
mutual-fund style products reduces
shareholder risk, but also increases
competition
We also see insurers exposed to
increasing competition on the investment
platforms themselves
21. 21
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European Insurers
Retail Distribution Review and Transparency
In the UK, the much increased transparency due to the Retail Distribution Review
(RDR) on fees and charges, as discussed in relation to funds, also adds to
competition, we believe. Similar regulation is about to be introduced in the
Netherlands, and we think there will be a trend for increased transparency across
Europe, either through regulation or consumer pressure. So although the UK is a
relatively small part of the European Life market, we think changes here are of
importance.
In the UK, these changes could impact platform providers which receive fees for
marketing funds. The first stage of RDR, implemented this year, ended
commission payments from fund managers to independent financial advisers
(IFAs) for recommending their products. This initial phase negatively impacted
sales at Aegon in Q1 13; we think Aviva is also at risk here, whereas Standard
Life remains well positioned. The second stage, to be implemented in 2014, ends
the payment of fund platforms by fund managers. Other open-architecture
platforms include Cofunds (recently acquired by Legal & General) and Skandia
(owned by Old Mutual). Other life insurers’ response to competition from
independent platforms might also be to acquire them, in our view.
Rising interest rates and the consumer
Rising interest rates are not positive on all fronts. Western consumers are still
relatively indebted, either through mortgages or loans and credit card debt.
Rising rates could impact here on disposable income and funds available for
more discretionary savings products, such as unit-linked policies and investment
bonds.
RDR in UK will increase transparency
around management and advice charges
We expect a trend for increased
transparency on management and agent
fees across Europe
Rising rates will impact on discretionary
spending power
22. 22
S&P Capital IQ Equity Research
European Insurers
5. Regulatory Issues
Solvency
‘It is easy to identify every stage of the economic cycle except
the one we are presently in’
We quote the above adage not by reference to the inherent difficulties of
macroeconomic forecasting and strategy, but with regard to some of the
intellectual headaches emerging in Solvency II regulation, which are discussed
below. Five companies in our coverage universe have recently been designated
as G-SIIs (Globally Systematically Important Financial Institutions). Although we
at the early stages, our first impressions are that this may be more significant for
those companies concerned than Solvency II, though the companies themselves
have yet to respond to proposals. We first briefly examine current capital ratios.
Solvency I ratios
Chart 5.1: Most recent Solvency disclosures for our coverage universe.
3.04
2.77
2.49
2.3 2.2 2.2 2.18
1.85 1.85 1.8 1.79 1.77
1.6
1.39
0
0.5
1
1.5
2
2.5
3
3.5
Source : S&P Capital IQ Equity Research, Company Report & Accounts, October 2013. KBC ratio applies only to the small
insurance operations.
As shown in Chart 5.1, Solvency 1 ratios look generally robust. Generali stands
out as one of the weakest, though a continuation of management actions
proposed early in 2013 could further improve this ratio1
. It has already risen
significantly since end of 2011, where it stood at 117%, well below peers. Generali
is targeting a 160% ratio, which we think it will achieve. It intends to achieve
160% by i) shifting business mix towards P&C and ii) improving its geographical
footprint, and iii) making strategic disposals. However we think achieving this
level will limit scope for dividend increases or further acquisitions, and disposals
also impact growth. Aviva is another of the more weakly capitalised insurers, and
like Generali is undergoing a strategic review to improve its capitalisation and
adapt its business mix. Its 27% dividend cut at the FY12 results (the share price
fell 13% fall on the day) illustrates how a weak capital position can impact on
1
In June 2013 Generali sold its minority stake in the Mexican companies Seguros Banorte Generali and Pensiones
Banorte Generali., improving its Solvency I ratio by 4ppts. Also in June 2013, Generali sold its US Life business to
SCOR, adding 1 percentage point to the Solvency I ratio.
Solvency 1 ratios mostly robust…
… except for Generali and Aviva, both of
which are undergoing strategic reviews
23. 23
S&P Capital IQ Equity Research
European Insurers
shareholder returns. It enjoys a significant diversification benefit due to its
composite mix of P&C and life divisions. We would note Prudential’s very strong
solvency ratio. Swiss Re publishes its own Swiss Solvency Test, where it scores
strongly (245% 2013).
Solvency II
The implementation of Solvency 2 continues to be pushed back and has now
been been delayed until 2016. We think key issues of debate include:
Illiquidity Premiums, or Matching Adjustments. This discussion applies to any
areas of financial solvency which involves long-term guarantees (LTG) but is
debated particularly in relation to annuity books. Insurers cash flow (or duration)
match - as best they can - assets to actuarially calculated streams of liabilities;
thus the assets are usually held to maturity. Typically these assets are relatively
illiquid, and the implied discount rate is higher than the risk-free rate and default
spread, supposedly to compensate investors for this illiquidity. There is historical
evidence that investors who do hold such securities to maturity, as insurers
mostly do, earn above the risk-free-rate post default: the illiquidity premium.
Insurance liabilities are, however, discounted at the lower, risk-free rate, and
assets are marked to market. Thus from a balance sheet, and accounting,
perspective this makes the insurer appear insolvent on a break even basis, but
also subject to fluctuations in credit spreads and liquidity.
Solutions to this problem include removing the illiquidity spread in valuing the
assets, but this would violate the market-consistent approach of Solvency II.
Alternatively, insurers could apply an illiquidity premium to the liabilities. As
insurance liabilities are ‘illiquid’, in that they cannot be traded, this makes sense.
But they are also contractually non-negotiable, and so in a sense ‘risk-free’, but
from the policyholder’s perspective. There are also significant challenges in
reliably identifying the part of a spread attributable to liquidity risk (These
challenges are discussed in EIOPA’s ‘Task Force on the Illiquidity Premium’
paper). So far the preferred solution is to allow an illiquidity premium to be
applied to the liabilities.
We think that history has shown the annuity-writers’ business model to be a
sound one. We think there is a case for reframing the debate and moving liability
discount rates from risk-free plus illiquidity to nominal less risk of default.
Table 5.1: Potential impact of Solvency II measures on illiquidity premiums
Most affected Unknown/Neutral Least affected
Life names (mostly) Multiline Nonlife names and banks
Legal & General,
Prudential
Aegon
Aviva
Generali
Swiss Re
Munich Re
Zurich Insurance Group
Allianz
ING
KBC Group
Sampo Group
Standard Life
Old Mutual
Source : S&P Capital IQ Equity Research, Company Report & Accounts. Oct. 2013
Countercyclical Premiums. One of the problems associated with market-
consistency, as espoused by Solvency 2, is that when markets become very
volatile, market consistent valuation can contribute to the volatility. Similarly to
the example above, it is argued that given insurers hold most of their assets to
maturity, they should not be exposed to higher capital requirements in times of
Chart 5.2: Bond nominal yields –
illustrative split
0%
20%
40%
60%
80%
100%
Yield to
redemption
Default
Default
uncertainty
IIliquidity
Risk free
Source: S&P Capital IQ Research, January 2012
Historically insurers have earned excess
returns through holding securities to
maturity
The countercyclical premium proposal
goes further, by adjusting liabilities both
upwards and downwards to reflect the
economic cycle
24. 24
S&P Capital IQ Equity Research
European Insurers
currency, spread and liquidity stress (although spread risk may be reflected in
real risk of default). This would be achieved through similar means to above
example: an additional discount on the liabilities. Conversely, it is argued that in
times of low stress, a lower rate should be used to encourage strong
capitalisation for more difficult times. There remains significant uncertainty over
how this would be implemented, and the criteria for its approval on different
business lines. We think that there is some merit to this idea – particularly given
the long-term nature of insurance, and its survival through the crisis – but it is
difficult to reconcile with the market-consistent principles at the heart of Solvency
II. An upward cap on the liability discount rate – presumably in times of strong
economic growth – may be a reasonable compromise.
We believe these proposals, in almost all forms, require a judgement on the part
of the regulator as to where we are in the cycle. We do not think this can be the
role of a regulator. In any case, we think the challenges of implementation would
be hard for both regulators and companies to overcome, not least by 2014.
Asset Allocation. With long-term liabilities, and difficulties in finding long-term
assets with yield to match them, insurers appear natural investors in projects
such as infra-structure, with long-term stable cash flows. Recently, Axa and Legal
& General have announced large infrastructure deals. Politicians and economists
are also hopeful that the sector can provide investment capital, which will help
drive growth, as banks all less willing to invest due to capital constraints.
Unfortunately Solvency II - in its current form - is still quite punitive of infra-
structure investment as an asset, often because of ratings of only BBB or so. This
is also the case in its treatment of corporate bond portfolios, which, as discussed
are often held to maturity.
We think there is a strong case for enabling insurance companies, with large
pools of capital and long-term illiquid liabilities, to invest in infrastructure and
other long-term projects.
Overall we expect the impact of Solvency 2, when it arrives, to be relatively
benign, with regulators taking a pragmatic approach to a sector which has
weathered the financial crisis well. Given the substantial (some estimates are
circa GBP3 bln for the UK alone) costs for the insurance industry, this may seem
underwhelming.
G-SIIs
Nine global insurers have been classified as Globally Systematically Important
Insurers, five of them European and within our coverage universe: Allianz,
Generali, Aviva, Axa, and Prudential. Our current conclusion is that this
development is a potential negative for shareholders of G-SIIs, due to increased
regulatory scrutiny, potentially higher capital requirements, and the possible
separation of certain insurance activities. There is an argument, adapted from
banking regulatory developments, that the implicit state guarantee the
designation of G-SII implies could offset the increased regulatory costs through
lower funding costs and higher credit ratings. We are slightly sceptical here,
noting that debt is a small component of an insurer’s balance sheet, which is
composed primarily of policyholder liabilities. On the other hand, Consumers
may be willing to accept higher costs in exchange for greater safety.
An upward cap on the liability discount
rate might be a reasonable compromise,
in our view.
Insurers make good providers of long-
term capital, especially in times of
austerity and bank deleveraging
Table 5.2: List of 9 G-SIIs
Name Region Mkt Cap
(USD bln)
Tot. Assets
(USD bln)
Allianz Europe 71.3 907.7
AIG US 71.8 537.4
Generali Europe 30.8 581.3
Aviva UK 18.9 485.4
Axa Europe 55.4 990.1
MetLife US 51.5 815.7
Ping An China 51.5 815.7
Prudential
Financial
US 51.2 516.5
Prudential UK 36.3 705.6
Source: S&P Capital IQ Equity Research. Oct. 2013
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European Insurers
Some detail on the proposals
A G-SII is one class of a G-SIFI (Globally Systematically Important Financial
Institution), a concept devised in response to the global financial crisis. The IAIS
is participating in a global initiative, along with other standard setters, central
banks and supervisors to identify G-SIFIs, and develop policy measures to reduce
the risk these organisations pose to the global financial system. It seems clear
that size is a key factor in classification (see Table 6.2), along with
‘interconnectedness’. Product mix, is also important. The core objectives of the
project are:
i) Enhanced supervision. Reduce the likelihood of another
financial crisis, and incentivise G-SIIs not to become too
systemically important.
ii) Effective Resolution. Ensure that distressed G-SIIs can be
wound down with the minimum of disruption to the financial
system, taxpayers and to policyholders.
In July 2013, the IAIS published an initial document outlining key concepts, the
nine G-SIIs, and a timetable of events. We comment on some of the main areas:
Separation of Traditional Insurance (TI) activities and Non-Traditional, or
Non-Insurance (NTNI) activities. It seems likely the events at AIG played a part
in this policy measure. The classification of activities here is important, as NTNI
activities will almost certainly demand higher capital requirements. It is
recognised by the IAIS that insurance is a fundamentally more stable business
than banking, with upfront payments of premiums and unlikelihood of a ‘run’ on
the insurers, equivalent to the banks. Put another way, (traditional) insurers have
long-term illiquid liabilities and (usually) liquid short-term assets, whereas banks
have long-term illiquid assets (e.g. mortgage books) and liquid short-term
liabilities (deposits or wholesale funding). Traditional activities typically include
those where the insurer can exploit diversifiable risk and the law of large
numbers, for instance classic P&C and annuity business1
.
In contrast, NTNI activities ‘involve financial features such as leverage, liquidity
or maturity transformation, imperfect transfer of credit risks, credit guarantees, or
minimum financial guarantees.’. The implications of the final of these are
important, as it includes a lot of popular life insurance products, such as Variable
Annuities and unit-linked accounts with guarantees, although there does seem to
be some recognition by the IAIA that, in certain cases, these products could be
treated as ‘traditional’. In fact, any activity which requires extensive hedging, or
dynamic use of derivatives appears to be captured here, due to increased risk of
modelling error, increased interconnectivity, counterparty risk, and dependence
on a functioning derivatives market.
With respect to dependence on the derivatives market, we tend to agree with the
line taken here, particularly when it applies to buying protection for systemic risk
factors, such as equity markets (US VA guarantees).
1
Although climate change and medical progress respectively may be considered systemic threats
here.
Many popular insurance products could
be classified as Non-Traditional…
…with potentially negative implications
for capital requirements
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Higher capital requirements. This looks highly likely for the NTNI activities, with
IAIS requiring ‘Higher Loss Absorption’ (HLA) for these activities. The IAIS has
indicated that for NI financial entities Basel III requirements will apply. NT
insurance financial entities will be subject to new capital requirements. It is not
clear how their concept of ‘interconnectedness’ will be reconciled with the
enthusiasm for diversification which has driven much financial thinking over past
decades.
Enhanced Supervision. The language here is quite strong: ‘Enhanced
supervision applies immediately to all G-SIIs to ensure they rapidly achieve the
higher standards of risk their G-SII status demands.’ The IAIS believe that in order
to effectively achieve policy objectives, the ‘inventory of policy tools should be
updated’, to include the authority to ‘increase liquidity requirements, impose
exposure limits, impose dividend cuts, and require additional capital and stress-
testing’.
Implementation Timeframe
We would highlight September 2014 (finalisation of new capital requirements),
and end 2015 (finalisation of HLA requirements) as key dates. The new higher set
of capital requirements are not assigned until 2017 and actually implemented
until 2019. It is plausible that given this timeframe and a stabilising
macroeconomic environment, some of the proposals may be moderated.
Table 6.1: Key dates for implementation of G-SII policies
Date Event
July 2014 Crisis Management Groups for G-SIIs established
September 2014 IAIS to finalise new (lower) set of capital requirements to
apply to all group activities, including non-insurance
subsidiaries
End 2015 Implementation details of HLA requirements
November 2017 Designation of G-SIIs where HLA will apply
January 2019 Implementation of requirements
Source : IAIS Policy Measures Document July 2013
Overall regulatory requirements look
likely to be more onerous
Actual implementation not planned until
2019
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6. Valuation
Conclusions
Our current forecast 12-month unweighted total return for our coverage universe
is circa 5%. Our P/TNAV vs RoTNAV (see chart 6.1) derived implied cost of equity
is circa 11%. This is broadly in line with our average (unweighted) cost of equity
for our coverage universe of circa 10.5%.
In terms of historical valuations, the sector is trading at around 8 year averages in
terms of forward PE and P/Book multiples. We are slightly wary of P/Book
multiples given the artificial volatility of IFRS book values discussed throughout
this document. We also consider Embedded Value based metrics in our valuation,
the extent to which depends on our analysis of payback periods, sensitivities, and
our confidence in the company’s assumption set.
In terms of potential sector performance, we see scope for:
i) Further equity risk premium (ERP) compression (we currently
assume around 6.5%) as economic fundamentals improve.
ii) Positive consensus earnings upgrades and surprises through
improving equity markets or, in the medium term, improving
fixed income yields. We are generally reluctant to explicitly
input risk asset returns into our forecasts, although technical
interest is a key component of P&C returns.
iii) Renewed confidence in Embedded Value metrics. The sector is
currently trading on circa 1.07x 2014E EV.
Chart 6.1: S&P 350 European Insurance Historical Valuation Multiples
0.00
0.20
0.40
0.60
0.80
1.00
1.20
1.40
1.60
1.80
2.00
0.00
2.00
4.00
6.00
8.00
10.00
12.00
14.00
2005 2006 2007 2008 2009 2010 2011 2012 2013
Cons FY1 PE (LHS) Cons FY1 P/B (RHS)
Source : Bloomberg. Oct 2013
We see several potential drivers for higher
valuations
Sector valuation multiples within
historical norms
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European Insurers
Chart 6.2: 2014E RoTNAV vs Price/2014E TNAV
Munich Re
ZIG
Swiss Re
Allianz
Generali
Aegon
Prudential
Standard Life
L&G H1 13
Aviva DGAviva
Old Mutual
ING
Axa
KBC
y = 10.1x - 0.1
R² = 0.9
0.00
0.50
1.00
1.50
2.00
2.50
3.00
0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0%
Source : S&P Capital IQ Equity Research Estimates, Company Data. Oct. 2013
Chart 6.2 above suggests an implied cost of equity for our coverage universe of
circa 10.5%.
Prudential stands out as having a high Price/TNAV. In part this is justified by the
high returns, in our view, but we would note that we place quite a high weighting
on its Embedded Value, which has relatively short paybacks and the company has
a strong track record of translating the ‘In-Force’ into IFRS profits and cash.
Standard Life looks somewhat expensive (falling on a 9% COE line), but we
would argue this is justified given i) its insensitivity to financial markets and ii)
asset management business model. Both Aegon and Aviva fall below the
regression, onto around a 13% COE line, which given their current circumstances
is probably justified. Generali falls above the line (implied lower COE), which
given its low capital and difficulties in its home market, we think suggests the
shares are overvalued.
RoTNAV versus Price/TNAV analysis
suggests a COE of c. 10.5%
Wide variety of P/TNAV multiples
reflects range of RoTNAVs and business
models
P/TNAV
RoTNAV
G of c. 1.5%
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Chart 6.3 displays the basic balance sheet valuations for our coverage universe.
The P/TNAV average of our universe is in line with the wider sector. There is quite
a broad range of multiples on both measures. The differences between P/TNAV
and P/EV are most pronounced in the predominantly life insurance names. Those
with significant Non-life operations, such as Zurich Insurance Group, Allianz and
Munich Re, display little difference. Swiss Re, KBC, ING and Aegon do not or no
longer publish EV accounts1
. Prudential stands out for its high P/TNAV multiple,
but average P/EV multiple. We would highlight the high IRRs and short payback
periods of its products, in particular in its Asian business. The Embedded Value
held up well throughout the crisis, driving IFRS profits growth, and suggesting a
robust assumption set.
Chart 6.3: Sector Coverage Balance Sheet valuation multiples
0.00x
0.50x
1.00x
1.50x
2.00x
2.50x
3.00x
3.50x
Price/EV 2014E Price/IFRS TNAV 2014E
Source : S&P Capital IQ Equity Research estimates. Oct. 2013
Graph 7.4 shows a similar pattern to 7.3, in the variation between Embedded
values and IFRS NAVs. EV PEs are typically lower2
, as a result of the more front-
loaded booking of expected profits. The overall sector is trading on around 1.07x
2014E EV, which for an expected 2014 RoEV of 13.1% (well above our Cost of
Equity of c.11%) suggests value in the sector.
1
Swiss Re publishes its own EV-style metric, EVM. ING is in the process of divesting its insurance operations. KBC is
predominantly a bank, and its insurance product mix relatively short-term.
2
Old Mutual publishes a higher EV multiple than IFRS PE multiple.
Prudential stands out for a high P/TNAV,
but we think this justified given its
consistent success in transforming EV In-
Force into IFRS profits
Embedded Value metrics suggest value in
the sector, given 2014E P/EV of circa
1.07x for a 2014E RoEV of 13%
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European Insurers
Chart 6.4: Sector Coverage Earnings Valuation Multiples
0.00x
2.00x
4.00x
6.00x
8.00x
10.00x
12.00x
14.00x
Price/EV EPS 2014E Price/IFRS EPS 2014E
Source : S&P Capital IQ Equity Research estimates. Oct 2013
Valuation Methodology
We use a mixture of approaches to derive our 12-month price targets. At present,
all of our companies are valued using a centralised valuation system, albeit with
the scope for differing weightings on various components. This allows for easy
comparison of trading multiples to ensure consistency of premiums / discounts,
and to calibrate overall valuations to fit with our market and sector views. Our
valuation has two main components:
1. A 5-year DDM projection. This uses our own model forecasts for years
FY1-FY3 followed by 2 further input EPS growth estimates. We apply a
suitable tail multiple at FY5 to derive our terminal value. This component
is good for valuing unusually high (or low) growth companies.
2. multiples-based component. We use, in various weightings, the
following multiples:
Price/Earnings. We try to use a qualitatively estimated
‘normalised’ earnings number here, which might be an average of
both the EV earnings and IFRS earnings.
Price/Tangible Net Asset Value (TNAV). Here we would normally
use FY1 and FY2 estimate from our model. This is a commonly
used metric when valuing P&C companies.
Price/Embedded Value (excluding Goodwill).
To decide on target multiples, we look at both Gordon Growth model justified
multiples, and also historical and current sector multiple ranges. For most
companies, we use 50% DDM, and 50% multiple-based weightings. Similarly we
usually equally weight the multiples-based component, with most of the variation
in how much we weight the EV component, if indeed the company publishes EV
data at all. This weighting would depend on how confident we are in the
company’s Embedded Value assumptions, disclosure and sensitivities.
Our 2014E valuation multiples are in line
with sector-wide consensus
We use a centralised valuation system to
ensure consistency and aggregate results
align with our sector view
Different valuation approaches (TNAV,
EPS) should all be consistent but help
prevent errors.
Weightings and target multiples allow for
analyst judgement
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Risks
Life Investment Risks
Rising equity markets can quickly filter through into higher assets under
management, and hence higher fees. A steepening yield curve improves the
attractiveness of many traditional life products, given the improved return
insurers are able to offer versus shorter term banking products. As noted, though,
these products are increasingly avoided by insurers, but would still impact the
significant back books of more traditional products. Overall rising interest rates
are a medium term positive, but would impact negatively on fixed income
holdings (and hence book values) in the short term. A sharp increase in rates
could cause customers to cancel policies (persistency) in favour of other products
offering higher returns, although cancellation fees may act as a deterrent. This
can be particularly negative for insurers if cancellation occurs early in the life
cycle of the product, given the payback periods of several years due to upfront
costs.
Non-Life Investment Risks
Catastrophes, both man-made and natural, can cause large losses for insurers.
However, often insurers can then push through significant price increases.
Perhaps of more concern are longer tail risks in casualty lines, where losses
continue to exceed expectations over a period of several years. Inflationary
pressure can increase claims more than expected. A difficult economic backdrop
can increase fraudulent claims, but also reduce frequency of legitimate claims
due to reduced activity (e.g. car driving).
Asset Management Investment Risks
Asset management divisions are exposed to capital markets, the levels of which
drive fee income. Consumer sentiment can influence retail inflows and outflows.
Interest rates impact on fixed income assets. There are regulatory risks around
custody of client assets.
Banking Risks
Banking is highly exposed to the economic cycle, through loan loss provisions,
loan growth and capital market activity. Interest rates are also a risk, impacting
earnings and asset/liability values. Banking is currently experiencing a high
degree of regulatory scrutiny, following the 2008 crisis, which led to government
intervention and higher capital requirements.
Regulatory Risks
The insurance industry is highly regulated. Solvency II regulation has been
delayed until 2016 and the impact of some areas remain uncertain. Nine global
insurers have also been designated as G-SIIs, again where the extent of
regulation or higher capital requirements remains uncertain.
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Glossary
Available-for-sale (AFS). Securities that have been acquired neither for short-
term sale nor to be held to maturity. These are shown at fair value on the balance
sheet and changes in value are taken straight to equity instead of the income
statement.
Combined Ratio. The sum of incurred losses and expenses as a percentage of
net earned premiums. If below 100 percent this indicates an underwriting profit
without taking account of investment income.
Embedded Value. Actuarially estimated economic value of the in-force life
insurance contracts of an insurer but excluding any value attributable to future
new business. Thus EV is equal (approximately) to the NAV plus the In-Force.
Endowment. An ordinary individual life insurance product that provides the
insured party with various guaranteed benefits if it survives specific maturity
dates or periods stated in the policy. In the case of the death of the insured within
the coverage period, a designated beneficiary receives the face value of the
policy.
Fixed annuities. Fixed annuity contracts (usually written in the US) allow for tax-
deferred accumulation of assets, and are used for asset accumulation in
retirement planning and for providing regular income in retirement. The contract
holder pays the insurer a premium, which is credited to the contract holder’s
account. Periodically, interest is credited to the contract holder’s account and
administrative charges are deducted, as appropriate.
Fixed indexed annuities. These are similar to fixed annuities in that the contract
holder pays the insurer a premium, which is credited to the contract holder’s
account and, periodically, interest is credited to the contract holder’s account and
administrative charges are deducted, as appropriate. An annual minimum interest
rate may be guaranteed, although actual interest credited may be higher and is
linked to an equity index over its indexed option period.
FSB. Financial Stability Board. The FSB was established in April 2009 as the
successor to the Financial Stability Forum (FSF). The FSB has been established to
coordinate at the international level the work of national financial authorities and
international standard setting bodies and to develop and promote the
implementation of effective regulatory, supervisory and other financial sector
policies.
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General Insurance. Property insurance covers loss or damage through fire, theft,
flood, storms and other specified risks. Casualty insurance primarily covers
losses arising from accidents that cause injury to other people or damage to the
property of others.
Guaranteed minimum accumulation benefit (GMAB) (US). A guarantee that
ensures that the contract value of a variable annuity contract will be at least equal
to a certain minimum amount after a specified number of years. This is typically a
‘rider’ on products such as Variable Annuities (VAs).
Health and protection. These comprise health and personal accident insurance
products, which provide morbidity or sickness benefits and include health,
disability, critical illness and accident coverage. Health and protection products
are sold both as standalone policies and as riders that can be attached to life
insurance products.
Hedging. A conservative strategy to limit financial loss by effecting a transaction
which offsets the underlying position. This does expose the hedging party to
counterparty risk, although it reduces asset risk.
IAIS. The International Association of Insurance Supervisors is a voluntary
membership organisation of insurance supervisors and regulators. The stated
mission of the IAIS is to promote effective and globally consistent supervision of
the insurance industry in order to develop and maintain fair, safe and stable
insurance markets for the benefit and protection of policyholders and to
contribute to global financial stability.
In-force. An insurance policy or contract reflected on records that has not
expired, matured or otherwise been surrendered or terminated. In Embedded
Value accounting, the ‘In-Force’ refers to the NPV of future profits on policies
which are currently active.
Inherited estate. For life insurance proprietary companies, surplus capital
available on top of what is necessary to cover policyholders’ reasonable
expectations. An inherited (orphan) estate is effectively surplus capital on a
realistic basis built over time and not allocated to policyholders or shareholders.
Investment-linked products or contracts. Insurance products where the
surrender value of the policy is linked to the value of underlying investments or
fluctuations in the value of underlying investment or indices. Investment risk
associated with the product is usually borne by the policyholder. Benefits payable
will depend on the price of the units prevailing at the time of surrender, death or
the maturity of the product, subject to surrender charges. These are also referred
to as unit-linked products or unit-linked contracts.
Net premiums. Life insurance premiums net of reinsurance premiums ceded to
third-party reinsurers.
Net worth. Regulatory basis net assets for EEV reporting purposes, these net
assets are sometimes subject to minor adjustment to achieve consistency with
the IFRS treatment of certain items.
New Business Contribution. The profits, calculated in accordance with
Embedded Value Principles, from business sold.
Non-Life Insurance. See General insurance.
Participating funds. Distinct portfolios where the policyholders have a
contractual right to receive at the discretion of the insurer additional benefits
based on factors such as the performance of a pool of assets held within the fund,
as a supplement to any guaranteed benefits. The insurer may either have
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S&P Capital IQ Equity Research
European Insurers
discretion as to the timing of the allocation of those benefits to participating
policyholders or may have discretion as to the timing and the amount of the
additional benefits.
Participating policies or participating business. Contracts of insurance where
the policyholders have a contractual right to receive, at the discretion of the
insurer, additional benefits based on factors such as investment performance, as
a supplement to any guaranteed benefits. This is also referred to as with-profits
(WP) business.
P&C. Property and Casualty Insurance. This term is often used interchangeably
with general insurance.
Variable Annuity A predominantly US product, similar to a unit-linked product
where the risk is borne primarily by the policyholder but the insurer guarantees a
minimum payment on occurrence of the event.
With-Profits Policies. A With-Profits policy is an insurance product where the
policyholder participates in the investment returns of the underlying funds. They
have been most popular in the US and UK, though Continental products have
similar features. Bonuses are added to the basic sum assured and are the way in
which policyholders receive their share of the investment profits of the policies.
There are normally two types of bonus:
Regular bonus – expected to be added every year during the term of the
policy. It is not guaranteed that a regular bonus will be added each year,
but once it is added, it cannot be reversed, also known as annual or
reversionary bonus; and
Final bonus – an additional bonus expected to be paid when
policyholders take money from the policies. If investment return has
been low over the lifetime of the policy, a final bonus may not be paid.
Final bonuses may vary and are not guaranteed.
Unit-linked life insurance A type of life insurance product with a savings
component, where the benefits payable depend on the performance of some
underlying assets. The investment risk is borne by the policyholder.
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Appendix
A Balance sheet leverage perspective on interest rates
We have aggregated data on fixed income holdings for each company in our
coverage universe, attempting where possible to break down the portfolios into
different groups reflecting the balance of investment risk between policyholders
and shareholders. This provides a somewhat crude assessment of stock exposure
to fixed income holdings.
Chart A.1:
Source: S&P Capital IQ Equity Research estimates, Company Report & Accounts. Oct. 2013.
37. Aegon NV
Equity Research
October 22, 2013
Financials
Netherlands
Bloomberg AGN NA
Reuters AGN
S&P STARS
Issuer credit rating A-
12-month target price
Current price
Forecast 12M total return (%) 7.7
Roderick Wallace, CFA
Equity Analyst
+44 20 7176 7208
roderick_wallace@spcapitaliq.com
EUR6.20
EUR5.96
Life & Health Insurance
Increase/decrease in target price
Benefits of recovering US offset by
hedging
Our recommendation is Hold. Recent indicators on the US economy have been
encouraging and group cost control measures are proving effective. However,
Aegon continues to report sales and profit declines in certain markets, and the
complex hedging arrangements to some degree offset benefits of improving US
conditions. Aegon’s restructuring has been mostly completed and in our view
provides a solid operating base alongside enhanced capital strength. The
solvency 1 capital ratio (IGD) was around 216% at Q2 13 (230% at Q4 12) towards
the upper end of the sector. The 2013E Price / Tangible NAV valuation of 0.56x is
at the lower end of the European sector, but has increased by circa 44% YTD in
2013, and our 2013-15 forecast returns on tangible NAV (RoTNAV) remain low at
around 8%, well below our estimated cost of equity of 11.9%. Management
targets an 8-10% ROE by 2015, which we view as challenging.
Downside risks to our target price and recommendation include competitive
pressures in variable annuities, credit risk in a declining US general account, the
impact of Solvency II, a persistence of low interest rates over the long term, and
unfavourable changes to Netherlands’ pensions regulation. Upside risks include
continued US economic recovery and a turnaround in the UK and Netherlands.
We use multiples (50%; 0.46x Tangible Net Asset Value, 6.5x EPS) and a five-year
Dividend Discount Model (50%) based methodology to derive our 12-month target
price of EUR6.20. These multiples reflect our high estimated cost of equity of
circa 12% and low ROE (circa 7%).
S&P estimate changes (%)
2013E 2014E 2015E
Revenues 0 0 0
Net profit 0 0 0
EPS, adj, dil. 0 0 0
Source: S&P Capital IQ Equity Research estimates
Key statistics (EUR mln)
Market capitalisation 11,203
No. shares (mln) 1,880
Beta (x) 1.50
Avg. daily vol ('000) 6,390
Shareholders' equity 22,293
Source: Company data, S&P Capital IQ Equity Research
Key forecast table (EUR mln)
Fiscal year end December 2011A 2012A 2013E 2014E 2015E CAGR (%)
Total revenues 28,391 41,782 25,410 26,872 28,260 -0.1
Gross premiums, non-life 0 0 n.a. n.a. n.a. 3.8
Gross premiums, life 19,521 19,526 20,588 21,573 22,678 3.8
Net profit -494 2,095 1,177 1,560 1,640 n.m.
EPS (EUR), adj, dil. 0.42 0.65 0.79 0.82 0.86 19.6
BVPS (EUR) 12.30 12.49 11.69 12.49 13.33 2.0
P/E (x) 14.2 9.2 7.5 7.3 6.9 -
P/BV (x) 0.5 0.5 0.5 0.5 0.4 -
ROE (%) n.m. 9.0 5.1 6.8 6.7 -
Dividend yield (%) 2.4 2.8 3.7 4.5 5.0 -
Source: Company data, S&P Capital IQ Equity Research estimates
Hold
38. 38
S&P Capital IQ Equity Research
October 22, 2013 European Insurer
Aegon NV -Price Performance
Target price history 36-month price performance
Date STARS Target
08-Aug-13 3 6.20
08-May-13 4 5.50
08-Nov-12 4 6.15
14-May-12 4 5.10
17-Feb-12 3 5.10
25-Jan-12 3 4.80
26-Oct-11 5 4.80
12-Aug-11 5 5.40
28-Jul-11 3 5.70
12-May-11 3 5.90 2.5
3.0
3.5
4.0
4.5
5.0
5.5
6.0
Oct 10 Jan 11 Apr 11 Jul 11 Oct 11 Jan 12 Apr 12 Jul 12 Oct 12 Jan 13 Apr 13 Jul 13
Source: S&P Capital IQ Equity Research, FactSet prices
Performance overview (Total return)
YTD 1M 3M 12M 36M
Aegon NV (%) 24.1 6.0 4.5 37.1 28.2
Peer group (%) 27.0 6.5 10.4 35.5 43.4
S&P Europe 350 (%) 14.1 1.6 6.5 16.4 18.8
S&P Europe 350 - Financials (%) 21.2 4.6 10.6 28.0 7.9
AMX General (%) 11.3 3.5 9.4 11.7 1.1
S&P Global 1200 (%) 13.3 -0.2 1.4 13.6 31.9
Source: FactSet, S&P Capital IQ Equity Research
Price relative to market – 12M Price relative to sector – 12M
4.0
4.2
4.4
4.6
4.8
5.0
5.2
5.4
5.6
5.8
6.0
S O N D J F M A M J J A S O
Aegon NV AMX General
4.0
4.2
4.4
4.6
4.8
5.0
5.2
5.4
5.6
5.8
6.0
S O N D J F M A M J J A S O
Aegon NV
S&P Europe 350 -…
Source: FactSet, S&P Capital IQ Equity Research Source: FactSet, S&P Capital IQ Equity Research
