Life Insurance And Annuity Companies Are Ripe For Strategies To Unlock Their Intrinsic Value

Sep. 16, 2021 9:17 AM ETAEL, ANAT, APO, ATH, BAM, BX, KKR, MET, NWLI, PFG, PRU, LNC, BAM.A:CA14 Comments
Houman Tamaddon profile picture
Houman Tamaddon
471 Followers

Summary

  • Life Insurance Companies have been operating in a challenging economic environment since the recession of 2008.
  • Declining interest rates and more recently rising mortality rates related to Covid-19 have resulted in lackluster growth and profitability for companies in this sector.
  • Many companies in this sector are undervalued and could be targets of acquisitions or partnerships by large asset managers like Brookfield Asset Management, KKR, Blackstone and Apollo.
  • Acquisition and merger targets will command a large premium to their current stock prices.

Close up of Life Insurance Policy
courtneyk/E+ via Getty Images

Life Insurance and Annuity Overview

Life insurance policy holders pay a regular premium or a lump sum amount to insurance companies in exchange for a future benefit upon the policy holder's death. The companies invest the premiums or lump sum payments. They earn profits when their investment returns are in excess of their future liabilities. Unlike many Property and Casualty (P&C) insurance companies, the liabilities of Life Insurance companies can extend into many years in the future. For example, a P&C company may write a policy to insure a car and collect premiums for typically one year. At the end of the year the liability ends and the company can book an underwriting profit (in case the claims are less than the premium collected) or a loss (in case the claims are greater than the premium collected). Life insurance companies' liabilities can extend for years or even decades into the future so it is more difficult for investors to assess companies' success in underwriting. Investors in P&C companies can examine combined and loss ratios to quickly assess companies' underwriting discipline. No such metrics exist for life insurance and annuity providers. Many investors are assuming the worst and predicting future losses for many of the companies in this sector. This has resulted in many of the companies in this sector to trade at a fraction of their book values and low price-earnings ratios.

Annuity purchasers pay a regular or lump sum payment to insurance companies in return for a stream of income in the future. Many holders aim to transfer the risk of outliving their wealth to the insurance companies. In exchange for paying the premiums or a lump sum, they assure themselves an income stream into their old age. Companies invest the customers' payments and hope to earn a higher return than their future obligations. Mortality rates and interest rates can have a large impact on the profitability of these contracts. Many companies sold annuities years ago when interest rates were significantly higher and thus have high minimum interest rate guarantees. The customers who purchased those annuities were promised higher rates of return than the current rates on investment grade Corporate or mortgage bonds that the companies invest in.

Life insurance companies in a way are similar to asset management companies. Essentially, they hold individuals' assets and invest them. They aim to earn a profit by managing the spread between what they promise in the future and what they earn on those assets. The industry is highly regulated. Retirees and heirs depend on these future income streams. Naturally the government does not want the insurance companies to go bankrupt and not be able to meet their obligations. For example, regulators require insurance companies to maintain certain risk-based capital ("RBC") ratios.

The secular decline in interest rates has provided headwinds for many companies in this sector. The yield on invested assets of these companies has been steadily declining since 2010. For example, in 2020 the yield on invested assets was 4.13% compared to 5.1% in 2011. However, the effect of interest rates on companies' profits can be complicated. When rates fall, insurance companies have to invest the policy holders' cash in lower yielding securities and thus the income earned may turn out to be insufficient to meet their future obligations. On the other hand, falling rates can boost the value of their current portfolio of bonds. That is why when rates suddenly fall as they did in April of 2020, many insurance companies recorded gains as a result of their rising bond prices. These gains (or losses in case of rising interest rates) are recorded as "unrealized fair market gains and losses" or "Accumulated Other Comprehensive Income" (AOCI). Conservative investors choose to assess companies' book values excluding AOCI. Many insurance companies intend to hold their bonds until maturation so a gain in market prices of these securities has little effect on their underlying businesses.

The challenging environment to life insurance and annuity providers is pushing many of them into alternative arrangements with other large asset managers and reinsurers. Some companies are also merging with each other and other asset managers. They form partnerships with private-equity firms or large asset managers that can invest the assets in more high yielding instruments. Large asset managers like Blackstone (BX), Brookfield Asset Management (BAM), KKR (KKR) and Apollo (APO) have been hunting for more assets to manage. Life insurance and annuity providers make excellent partners since they have been struggling with making adequate returns on their capital and they have plenty of capital to invest.

Another possible catalyst for improving the fortunes of this industry is the reversal of the interest rate trend. Annuity and life policies sold now will surely have lower guaranteed interest rates associated with them than in the past. If rates rise the companies in this sector will be able to obtain higher returns on their assets and easily meet their future obligations. To be sure, no one can predict the future direction of interest rates. A rising rate environment is far from certain despite rising inflation which the Fed claims is temporary. We can all be reasonably certain that rates cannot fall significantly below zero where they stand about now.

An earthquake or a flood leads to an increase demand for earthquake and flood insurance products and premiums. The pandemic similarly will change consumers' habits in how they consume life insurance products. It will likely increase the demand for Life insurance products in the future as people become more aware of their mortality. Despite record low interest rates, annuity sales surged 41% in the fourth quarter of 2020 compared to 2019. This rise is occurring at the same time as some insurance companies like Prudential (PRU) are planning to cease the sale of these products. The Passage of SECURE Act signed into law in December of 2019 will likely contribute further increases in annuity sales. The law allows annuities to be purchased in retirement accounts.

Source: Yahoo, Value line

Investors are currently punishing life insurers and annuity sellers. Most of these companies are trading at a fraction of their book value and at price-earnings ratios well below companies in other industries as can be seen in the table above. As a comparison the average PE and P/BV of the S&P 500 is 34.69 and 4.74 respectively.

Below I will review recent actions taken by some of the companies in this sector to alleviate their woes. There are many other examples in this sector and we are sure to see many more in the coming years.

American Equity Investment Life and Brookfield Asset Management

In October of 2020, Massachusetts Mutual Life Insurance and Athene Holding (ATH) offered to buy American Equity Investment Life (AEL) for $36 a share or about $3 billion. At that time private-equity firm Apollo had a 35% stake in Athene. Apollo, unlike traditional insurance companies, is more comfortable with investing in assets other than corporate bonds which allows it to earn higher returns than companies like AEL that typically invest in corporate and mortgage bonds. As expected AEL's stock price surged from about $20 to $33 after the announcement. The three buyers (Apollo, MassMutual and Athene) were all savvy buyers who were knowledgeable of the industry. The fact that they were offering almost a 100% premium to AEL's stock price demonstrated the hidden value of AEL. One would think that AEL management and shareholders would be thrilled with that offer. Amazingly the company rejected the offer.

Shortly after that announcement, Brookfield Asset Management, one of the world's largest asset managers with over $600 billion of assets under management, announced a partnership with AEL. Brookfield eventually took a 19.9% ownership in AEL. The initial 9.9% was obtained at $37 a share (a slight premium to MassMutual/Athene deal but AEL maintained its independence). The remaining 10% was purchased at the greater value of $37 per share or adjusted book value a few months later.

Global Atlantic and KKR

In July of 2020, KKR, another large investment company with over $500 billion of assets announced that it will acquire Global Atlantic, a life insurer as well as one of the largest annuity providers. KKR purchased Global Atlantic for $4.4 billion which was 1.0X their book value.

American National Insurance and Brookfield Asset Management

In August of 2021, BAM agreed to buy American National Group (ANAT) for $5.1 billion or $190 per share. This deal has not been finalized and is at about 80% of ANAT's book value. No competing bids have emerged yet. ANAT's products include life, health, annuities and property and casualty insurance.

Apollo and Athene

In March of 2021 Apollo announced that it will merge with Athene in an $11 billion all-stock deal. Apollo already had a 35% stake in Athene and was providing asset allocation services for Athene in exchange for fees. Athene's stock price like many other life insurers was underperforming the market. Upon completion of the deal which is expected to be completed in January of 2022, Apollo shareholders will own 76% of the combined company.

National Western Life and Prosperity Life Assurance

In December of 2020, National Western Life (NWLI) ceded to Prosperity, a reinsurer based in Bermuda, liabilities of vintage fixed rate and payout annuity contracts. This action transferred much of the risk from NWLI to Prosperity in exchange for a $48 million commission which almost doubled NWLI's RBC ratio to 785%, well above the level desired by regulators. The agreement transferred the credit and interest risk to the reinsurer.

Final Thoughts

As the above deals depict, the Life insurance industry is ripe for consolidation and deals that can unlock value from many of the undervalued companies. The industry is mature and dominated by large well know players like MetLife (MET), Prudential, and Principal Financial (PFG). While the larger companies may not be ideal acquisition candidates, they still have opportunities to unlock value by partnering with asset managers and reinsurers. Many of the smaller companies are ripe for acquisition as well as other strategies that can unlock value. Investors would be wise not to ignore this unfavored sector which offers many opportunities to value seekers.

This article was written by

Houman Tamaddon profile picture
471 Followers
Anesthesiologist. Allocating more of my time from medicine to investing. Invest for the long term and am willing to sacrifice short term returns for a large return in the future.

Disclosure: I/we have a beneficial long position in the shares of NWLI, ANAT, AEL either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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