US Life Insurance Marketweight
Analyst(s): FPK CCW US Equity Research 212 687 1105
1Q’08 Preview: Complicated Quarter With Likely Misses
• Few earnings positives this quarter. Q1’08 is likely to show overall negative earnings
fundamentals for the life group given: 1) declining equity markets and the impact on AUM / equity
based fees (linked QoQ S&P declines of 10%; 2) elevated volatility producing hedging breakage; 3)
lower yields / weak returns from alternative assets (hedge fund indexes negative 1% to 6%, etc.); 4)
spread widening and mark to market losses on select investment / CRE conduit holdings; and 5)
potentially less favourable mortality, a typical Q1 event (although not expecting adverse experience).
• Expect more misses than beats. In our universe, we see potential for misses from current Street
estimates for LNC, HIG, PRU, NFS and PL. Further, we don’t see many catalysts for beats, but have
more confidence in AFL, AIZ TMK, and UNM. NFP, SFG and RGA remain the hardest to call, although
particularly with SFG and RGA we believe estimates appear reasonable and factor in seasonality.
• Are earnings misses expected? We continue to feel that earnings misses are priced into valuation
and largely expected, but given some move off of YTD lows still see some risk on the news. One
notable is LNC, which suggested about $0.10 to $0.15 per share softness from equity weakness,
hedging breakage and negative alternative gains, but backed the annual repurchases (suggesting
comfort on balance sheet strength / credit) and the shares have trended generally with the market.
• Credit still a focus, but don’t see risks in buybacks. Updates on marks in subprime, Alt-A,
CMBS, ABS will again be a main consideration, and based on spread widening/continued
dislocation in credit markets expect losses to expand. However, we would be surprised to see
revisions to capital mgmt plans of companies in our universe, which will likely be viewed positively.
• Other keys. 1) Encouraging sales on VA, which are looking up mid-single digits based on
anecdotal Jan/Feb data (showing benefits of product guarantees mitigating typical mkt correlation).
2) We expect passing marks for VA hedging, with declines in equity markets, high volatility and
lower interest rates (testing the three key “greeks” at once). Expect some hedging breakage, but for
this to be relatively small in the grand scheme. 3) Mortality trends can be a Q1 risk, but our
anecdotal discussions suggest a “normalized” mortality quarter. 4) We don’t expect material DAC
unlocking charges from VA writers, despite lower equity markets. 5) FAS 157 will impact book,
but is largely known.
• How to play the quarter. We favor some of the lower earnings risk names going into the quarter,
including AIZ, UNM and TMK. We believe they are more likely to meet estimates and, in our view,
have lower risk investment portfolios. On the more equity sensitive names, we would look for
potential pullbacks on earnings misses to opportunistically build positions, particularly given our view
that misses are generally priced into valuations.
• Earnings / price target revisions. We are lowering our quarterly and/or annual estimates on PRU,
PL, CNO and RGA (quarterly only, annual remains consistent) and raising AFL based on foreign
exchange. We are also adjusting price targets on several names based on updates to target
multiples.