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Primer on Life Insurance


ubuy2wron
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Can anyone here point me towards a decent primer on Life Insurance companies. I have noticed that Lifecos generaly are pretty depressed in price but I have never quite understood  what kind of mental construct I should be using when valuing a life insurance co.

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I would not touch life insurers. Their liabilities have not changed but the bonds have been hovering around 1% and will probably be there for a while. Japan's life insurers got hit pretty hard in the 90s. I had shares in NWLI last year but moved out because of it.

 

BeerBaron

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I sold all pwf, slf, and mfc out of my margin accounts.  Still have smallish positions in my registered accounts where I have a 20 year horizon - they still pay dividends.

 

Lifecos have to hold liquid securities for policy holders.  These liquid securites are treasury bonds.  In the case of the above names the t-bonds would be in cnd and us depending on where the policy holders are.  With the extreme low interest rates the bonds are often yielding less than the policy holders have been promised as payouts.  With each passing Q with low interest rates the lifecos have to increase policy holder reserves.  I cant speak to Gwo but slf and mfc have hedged themselves against low bond yields but this only works to a point.  They dont want to overhedge due to future portfolio drag. 

 

Add to this pending retirements for baby boomers and you start to see long horizon drags on earnings. 

 

Then there is the mutual fund business that each has.  Pwf Between gwo and igm is the largest mutual fund co. In Canada.  Mfc and slf both have mutual fund business in the Us and Canada.  Needless to say the mutual fund business is subject to market whims and with lower returns fee income is going to get squeezed by etfs etc. 

 

Bright spots: mfc and slf have a growing presence across Asia.  I wouldn't hang my hat on that as it is a small piece of their business, and I expect it is difficult to dividend cash up to the holdco. levels.

 

Finally, these businesses make Bac easy to comprehend. 

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I sold all pwf, slf, and mfc out of my margin accounts.  Still have smallish positions in my registered accounts where I have a 20 year horizon - they still pay dividends.

 

Lifecos have to hold liquid securities for policy holders.  These liquid securites are treasury bonds.  In the case of the above names the t-bonds would be in cnd and us depending on where the policy holders are.  With the extreme low interest rates the bonds are often yielding less than the policy holders have been promised as payouts.  With each passing Q with low interest rates the lifecos have to increase policy holder reserves.  I cant speak to Gwo but slf and mfc have hedged themselves against low bond yields but this only works to a point.  They dont want to overhedge due to future portfolio drag. 

 

Add to this pending retirements for baby boomers and you start to see long horizon drags on earnings. 

 

Then there is the mutual fund business that each has.  Pwf Between gwo and igm is the largest mutual fund co. In Canada.  Mfc and slf both have mutual fund business in the Us and Canada.  Needless to say the mutual fund business is subject to market whims and with lower returns fee income is going to get squeezed by etfs etc. 

 

Bright spots: mfc and slf have a growing presence across Asia.  I wouldn't hang my hat on that as it is a small piece of their business, and I expect it is difficult to dividend cash up to the holdco. levels.

 

Finally, these businesses make Bac easy to comprehend.

Is not the life insurance part of the business the ultimate long tail business the float lasts an awfully long time it would seem to me that a Watsa type fixed income investor could generate some interesting returns for shareholdsers and does not a very low interest rate increase the rates for new policies written. One would have to assume that this industry is facing obstacles why else would the stocks be so cheap I am really looking for some kind of primer on lifeco,s as an invesment . I can easily look at BRK and FFH and other P&C insurance companies and see where the low hanging fruit lies. I presume with a life co it is impossible to have any real underwriting advantage it would seem the winners and loser would be determined by investing acumen and marketing prowess. I have never understtod MFC there are just too many moving parts for me to get a handle on I suspect that PWF and GWO may be cheap but I have no conviction.
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If memory serves ubuy2wron, you are a shareholder of E-L Financial. You should call Paul Taylor (ELF CFO) at 416 947 2578 and arrange a meeting with him or someone at Empire Life. I was in there not long ago and they offered me a meeting with the head of the Dominion (P&C). I can only imagine they would do the same with Empire Life. Otherwise, Paul may be a good source. And a nice fellow. Reading ELF's annual reports, specifically with regards to Empire Life, offers some limited colour on the operation as well, but I suspect you've been doing that.

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Reading ELF's annual reports, specifically with regards to Empire Life, offers some limited colour on the operation as well, but I suspect you've been doing that.

 

Correction, reading ELF is a good way to fall asleep faster then I can write this pos.........zzzzzzzzzzzzzzz.

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Ubuy2wron, the float last a long time but is very restricted to policy holders.  That and the sheer size of AUM makes watsa style investing near impossible.  When things are going their way these things pump out cash as they did after demutualization.  Now they look to be just treading water.  I have no doubt that very long term they will be good investments but in that same time period I will have 10x the return so I take a pass.

 

Watsa has steered clear, and even divested inherited Lifeco holdings over the years.  Buffett has none.  That says alot to me.  Watsa talks about a run on assets from the policy holder side that forces one to liquidate at the most inopportune time, which of course works counter to his style of having cash when others dont. 

 

Dont know about Elf.  Hadn't noticed it had gotten so cheap.

 

 

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Is not the life insurance part of the business the ultimate long tail business the float lasts an awfully long time it would seem to me that a Watsa type fixed income investor could generate some interesting returns for shareholdsers and does not a very low interest rate increase the rates for new policies written. One would have to assume that this industry is facing obstacles why else would the stocks be so cheap I am really looking for some kind of primer on lifeco,s as an invesment . I can easily look at BRK and FFH and other P&C insurance companies and see where the low hanging fruit lies. I presume with a life co it is impossible to have any real underwriting advantage it would seem the winners and loser would be determined by investing acumen and marketing prowess. I have never understtod MFC there are just too many moving parts for me to get a handle on I suspect that PWF and GWO may be cheap but I have no conviction.

 

The two key problems with life insurance float are:

 

1) They are subject to runs - policyholders can surrender their policies. With P&C business, once the policies expire the money is locked in as float until claims have to paid out. So, the life business is not unlike the banking business where you borrow short and invest long.

 

2) Life insurers are committed to very long term pricing. If they get it wrong, they will be screwed for a very long time (as we are seeing MFC experience over the past few years). Also, for some products, they commit to very long term fixed returns to their customers. These fixed returns cause problems when you have severe economic environments when interest rates go either very high or very low because policyholders can act selectively against the insurer.

 

The current economic environment where we might have a prolonged period of abnormally low rates which oculd then be followed by a period of high inflation and interest rates is excatly the mix that is not good for lifecos. Their spreads suffer when rates are low; and they are vulnerable to surrenders when rates go high. Investing the float without certainty of the duration of liabilities is a major problem.

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re 1) They are subject to runs - policyholders can surrender their policies

 

If a person has paid premiums for say 5 years, then they surrender their policy-does the lifeco not keep all the premiums paid? i would think this would be good for the Lifeco.

 

Pricing + low return on bonds-i can see how these are a problem.

 

I understand that a lot of lifeco. went under during the 1930's and in Japan during there great recession.

 

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Pssst.  ELF is selling for a shade more than 50% of BV.

 

Keep it secret!

 

 

SJ

Its better than that the company is buying back shares daily through the purchase of EVT which holds about 40% of its NAV in ELF and sells at a steep discount to its NAV, actually on most days it has the highest discount to NAV of any closed end investment trust in NA. ELF is my largest holding and I am trying to buy more. Actually the only thing more soporific inducing than reading the annuals is waiting for it to trade.
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My understanding of the lifecos is that their business is affected by:

 

1) The level of interest rates as they use: a) bonds to invest premiums received, and; b) current rates to discount policy liabilities.

2) Competition: the business is very competitive and each new policy incurs large initial costs (think commissions to salespeople).

 

The strain of low interest rates on float is additionally hampered by low discount rates on liabilities and high underwriting expenses if policy count is growing. The things that offset these headwinds are life expectancy and policy lapses. The lifecos want their customers to live longer than they project and lapse their policies.

 

In an environment of low interest rates and mature, competitive markets, lifecos have poor margins. In order to combat this, they try to reduce business growth and the high costs associated. It risks relationships with salespeople, but it is one of the only levers they have. Unless they go to markets which are growing and lack competition.

 

ELF has stated that they are slowing new policy growth in this environmnent in order to improve poor margins.

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My understanding of the lifecos is that their business is affected by:

 

1) The level of interest rates as they use: a) bonds to invest premiums received, and; b) current rates to discount policy liabilities.

2) Competition: the business is very competitive and each new policy incurs large initial costs (think commissions to salespeople).

 

The strain of low interest rates on float is additionally hampered by low discount rates on liabilities and high underwriting expenses if policy count is growing. The things that offset these headwinds are life expectancy and policy lapses. The lifecos want their customers to live longer than they project and lapse their policies.

 

In an environment of low interest rates and mature, competitive markets, lifecos have poor margins. In order to combat this, they try to reduce business growth and the high costs associated. It risks relationships with salespeople, but it is one of the only levers they have. Unless they go to markets which are growing and lack competition.

 

ELF has stated that they are slowing new policy growth in this environmnent in order to improve poor margins.

They want customers to lapse their policies, I understand that lifecos build in a lapse policy factor when pricing product. What are the drivers that cause policy holders to lapse. If we look at a GIF as an example which MFC has a greater exposure than most. Does the poor performance of the policy cause an increase of the lapse rate obviously if you are 80 years old and have terminal cancer you are not going to lapse however if you are 50 and healthy you very much are.
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Surrender is a good thing for the Lifeco's.  The negative thing would be these variable universal life product they sell that sometimes carry a minimum guaranteed return.  Some companies has a pretty exposure to the market there.  You have to dig into the K's and Q's to find that info, sometimes not even disclosed.  Back in '09, I was offerred a product by Metlife with a minimum guaranteed return of 7%.  That's when all their portfolio was marked down, and probably have some regulatory capital concerns.  A way to avoid that risk would be to look at the reinsurers who only look to arbitrage longevity risk and bond yields.

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Today’s Lifeco purchase is for positive carry. Simply buying MFC common with 60% margin @ 4.25% will produce a net yield of > 4% on the equity invested. Captures spread & appreciation, but creates an exposure to higher margin rates & a possible dividend cut.

 

Not popular, & over the medium term the Lifeco may not do so well, but it is not really relevant – Brand Name & Quality is. IE: MFC: Take the closing price on its first day of trading, adjust upwards for inflation, & compare it to the price today.  Is the 12 yrs of intervening business growth in a name plate OSFI regulated company - really only worth a premium of 11%?   

 

SD

 

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The impact of surrenders is not straightforward and even though in some situations insurers make money from surrenders, generally speaking surrenders are not a good thing for insurers.

 

Because of new business strain (caused by high upfront costs), surrenders in the early years of a policy result in losses. This is a negative.

 

After a policy has been in force for a while, surrenders do throw up gains for lifecos via the release of surpluses. (Policy reserves in excess of cash surrender amounts paid out.) While this provides a short term boost to profits, there is a negative long term impact to the insurer - because they lose the future profits from the policies. These lost revenues then have to be replaced with revenues from new policies which introduce the drag of new business strain.

 

The most negative and dangerous impact of surrenders is when interest rates rise sharply. Policyholders holding policies bought when interest rates were lower (thus providing lower rates of implied return) now have an incentive to surrender their policies and reinvest in higher yield instruments. Because this happens at a time when interest rates are elevated and therefore investment values are depressed, the insurers are forced to liquidate discounted investment assets to pay off policyholders. There is another negative dimension. Healthy policyholders (i.e. those still insurable) are more likely to surrender than those who are uninsurable - this will end up skewing the mortality risk of the insured lives that stay on the book.

 

In any case, my original post was in response to a comment about using life funds as float. The danger of unpredictable surrenders is what makes life insurance float risky and thus less attractive than general insurance float. This is why neither Buffett nor Watsa are interested in life insurance float. In fact, I believe Prem used to work at Confederation Life which experienced such a run (must confess my recollection is vague and someone else may be able to give a better account of what happened).

 

I would add that term life as well as life reinsurance policies do not have these problems because they work more like general insurance. I don't think, however, there are companies that do only these types of business. Wonder why Buffett or Watsa are not interested in this form of float - what I am missing?

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