Despite scandals, investors eye insurance stocks

Jun 20, 2005 @ 12:01 am

By Gary S. Mogel

NEW YORK - Improving financial fundamentals are drawing investors back into the insurance sector, even with the continuing investigations by federal and state regulators, according to industry observers.

Life insurance stocks look particularly attractive to some.

The investigations haven't had much of an effect on insurance companies except for New York-based American International Group Inc. and companies involved in its transactions, said Malcolm Polley, chief investment officer of S&T Wealth Management Group. The Indiana, Pa., firm has $1.2 billion in assets under management.

"Some insurance stocks went down, but that created a buying opportunity," Mr. Polley added.

Low volatility, high ROE

Life insurers had the lowest 2004 earnings volatility and second-highest return on equity of the six types of insurers in the sector, according to a study of 80 publicly held insurers which was released this month by Chicago-based reinsurance broker Aon Re Services Inc. The study measured volatility and ROE over periods ranging from one to five years.

"Investors place a large amount of emphasis on earnings growth and earnings volatility," said Michael Bungert, president of Aon Re. "Less volatile earnings will, over time, contribute to increased shareholder value."

Life insurers experienced 85% lower volatility last year than they did in 2003, while the entire insurance sector combined had 21% lower volatility. The ROE was 11.8% for life insurers, second only to personal-lines insurers, which had an ROE of 16.1%.

"The prognosis for life insurance companies is strong, as the aging population needs products that help them save for retirement," said Henry Essert, managing director of Mercer Oliver Wyman in New York. Insurers also have become more effective in their investment strategies, hedging and product design, he added.

The combined ROE for the insurance sector was 10.6%. The other kinds of insurers studied were those that specialize in commercial lines, specialty lines, reinsurance (the most volatile) and health insurance.

Investment firms take notice

"Earnings stability is a factor that affects 10.7% of the variables that are used in the construction of our quality measure," said Cynthia Crossland, a spokeswoman for ICON Advisers Inc. in Greenwood Village, Colo., which has $4.5 billion under management.

She added that all ICON research is quantitative. Its investment decisions are based on financial screening, including measuring volatility and ROE, and not on bad publicity or news events.

"We currently see more value and stronger leadership in several industries within the financial sector and are taking an increased position in insurance-related industries," Ms. Crossland said. She noted that the firm, pursuant to its sector rotation strategy, is moving holdings from the materials sector into insurance and other financial stocks.

Mr. Polley favors life insurance companies that specialize in tax-deferred vehicles such as variable annuities, as this line has the most potential for growth. Cost of mortality per policy is going down, which is another factor that makes life insurance stocks more attractive, he said.

Mr. Polley particularly likes some of the smaller property-casualty insurers and Old Republic International Corp. in Chicago, a multiline insurer with a small life insurance unit. The company was the least-volatile commercial lines insurer, according to the Aon Re study.

The three least-volatile life insurance companies were Torchmark Corp. in Birmingham, Ala., Nationwide Financial Services Inc. in Columbus, Ohio, and Jefferson-Pilot Corp. in Greensboro, N.C.

Multiline (property/casualty and life) insurers have a value-to-price ratio of $1.39, noted Derek Rollingson, portfolio manager of the ICON Financial Fund, which manages $155 million. "Fair value" is pegged at $1, so these insurers are 39% above average, a "very good" valuation, according to Mr. Rollingson.

The ratio for life insurers is $1.36. In the life sector, he likes Newark, N.J.-based Prudential Financial Inc. and New York-based MetLife Inc., both of which are up about 13% from their April lows.

Insurers that write only property and casualty tend to be more volatile because that line is more at the mercy of the underwriting and interest rate cycles, Mr. Polley noted.

"Cost of float is key to determining an insurance company's prospects," he said. "Float is basically premiums received less loss reserves - money that the insurance company can invest."

Another important factor is that insurers for the most part no longer pay contingent commissions, which were curtailed as a result of the investigations. "Not having to pay contingent commissions resulted in a profit spike for insurers, although the brokers suffered," Mr. Polley said.

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