Tuesday, March 11, 2008

Life Insurance Cos are Trading Close to Trough Levels

RBC Capital Markets, 11 March 2008

Shares of lifecos are trading close to trough levels after having fallen considerably in 2008 - down 5% in the past week, and almost 17% year-to-date. We believe that valuations are such that adding to lifeco positions at current levels has more upside potential than downside risk in spite of the difficult macro environment.

• The YTD decline is worse than the 13% decline for the Canadian banks.

• As we outlined in our February 15, 2008, Q4/07 review, the macro environment is difficult for lifecos. The Canadian dollar is high, long-term interest rates are low and the equity and credit market outlook more uncertain.

• Our estimated EPS growth of 10% for the sector in 2008 is lower than what the companies have delivered in this decade, reflecting the difficult environment, but 10% ranks the lifecos well-ahead of the banks (0% expected growth) and property and casualty insurers (expected decline of 1%).

• On a P/E basis, the lifecos now trade 17% below the historical average multiple (since 2000) and only 2% above the average trough. The banks, on the other hand, are not trading at trough valuations on a P/BV basis, in spite of their severe share price declines.

• We still have faith in our lifeco earnings estimates, although quality may deteriorate, which is why we think using P/E is still the best way to value the lifecos. We believe P/BV is more useful for banks given the uncertainty surrounding their 2008 earnings.

• Key potential earnings drivers for the lifecos include the earnings that should be generated from past sales, recent business growth, and the integrations of acquisition (particularly Great-West and Sun Life). We also believe that life insurers may benefit from actuarial reviews of reserves in areas where they may have historically been overly conservative. We view the two biggest near term risks to our forecasts as currency fluctuations and declines in equity markets.

• IAG and GWO are trading at trough P/E multiples and only 8% from trough P/B multiples.

• IAG's low P/B multiple is noteworthy as the company earned an ROE of 15.5% in 2007 – 300 basis points higher than it earned during its P/B trough. IAG's shares are also cheap as they currently trade in line with 2007 embedded value per share. We believe IAG should trade at least at a 20% premium to its EmV, given that the company's ability to grow its EmV per share (10% per year on average since 2000). Outside of the negative impact of equity markets, we believe EmV is growing.

• We think that a better way to play GWO is via Power Financial, which we upgraded to Outperform - see our separate report.