Lifecos: Desjardins Calls for More Disclosure on Equity Market Sensitivity

Includes: GWLOF, MFC, SLF
by: FP Trading Desk

While insurance companies proved to be sensitive to stock markets on the way down, the same case can be made on the way up during this recent rally. Last fall, this sensitivity increased as off-balance sheet guarantees were assumed to be in the money.

With lifecos in Canada and the U.S. having fallen much further that the S&P/TSX composite index and S&P 500, respectively, there is a growing call for better disclosure about this sensitivity.

Desjardins Securities analyst Michael Goldberg told clients:

“If this information had been better understood before stock markets plunged in the second half of 2008, investors would have had a better sense of potential risks on an absolute as well as relative basis."

He noted that since September 2008, the S&P 500 has fallen by 29% and the TSX by 24%, while U.S. lifecos have declined 64% and their Canadian counterparts 55%. That equates to two or three times the market declines. U.S. and Canadian banks, meanwhile, have lost 54% and 32% of their respective values during the same period, which shows they are less sensitive to equity markets.

While Manulife Financial Corp. (NYSE:MFC) appears to be the most sensitive lifeco to equities, Mr. Goldberg still calls Canada the ‘Goldilocks of the insurers.’

He said:

“Market movements and sensitivity had explained a large portion of the relative performance of life insurers around the globe in the early 2000s, with the worst performance from European companies, followed by U.S., then Canadian companies."

During the stock market decline and credit downturn of the early 2000s, it was relatively straightforward to understand what was expected from insurance companies in the U.S. and Europe. European insurance companies often had a substantial portion of their investments tied to their surplus capital invested in equities. Mr. Goldberg points out that this time around, European lifecos had equity investments equivalent to 80% to 100% or more of their surplus. “So when stock prices dropped by 30%, a significant chunk of their capital vapourized, which constrained their ability to grow.”

U.S. lifecos got hit because of their investment for income – earning them the label ‘yield hogs.’ They held a significant amount of high-yield debt and insurers who had been downgraded to non-investment grade, the analyst explained, which lead to many credit problems.

But Canadian lifecos, who invest for total return, did not suffer from these extremes. Mr. Goldberg says the domestic landscape is therefore like a bowl of porridge that is neither ‘too hot nor too cold,’ due to its balance of equity and debt investments.

If insurers provided additional disclosure in terms of their exposure to equity investments, he insists the sell-off in their shares would have been less indiscriminate and it would make it easy for analysts to predict these trends.

He added:

“This would have provided a more dynamic picture of the market equity exposure of life insurance companies than we currently have. Not only would disclosure of this nature have been beneficial for investors for the reasons mentioned above, but also for the companies as they were affected by the indiscriminate sell-off resulting from uncertainty and fear of the unknown.”