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Jimmy S. Bhullar
(1-212) 622-6397 jimmy.s.bhullar@jpmorgan.com
Source: Company reports and JPMorgan estimates. NTM ROE = Next 12 months estimated earnings divided by 9/30/03 book value per share including unrealized gains or losses. Note: Data in this table reflect 1/13/04 closing prices; all other data in this report reflect 1/12/04 prices.
http://mm.jpmorgan.com See last two pages for analyst certification and important disclosures, including investment banking relationships. JPMorgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
Table of Contents
Investment Thesis: Back on Track ...........................................................................3 Primer Summary .......................................................................................................7 Macro Earnings Drivers............................................................................................8 How to Make Money in the Sector .........................................................................10 Life Insurance Success Factors...............................................................................12 Distribution...............................................................................................................15 Historical Perspective ..............................................................................................18 Key Industry Valuation Metrics.............................................................................19 Product Capsule: Variable Annuities.....................................................................23 Product Capsule: Fixed Annuities..........................................................................29 Product Capsule: Equity-Indexed Annuities.........................................................33 Product Capsule: GICs, Funding Agreements (FA) .............................................36 Product Capsule: Universal Life ............................................................................39 Product Capsule: Whole Life..................................................................................41 Product Capsule: Term Life ...................................................................................43 Product Capsule: Variable Life ..............................................................................45 Product Capsule: Group Life..................................................................................49 Product Capsule: Disability Insurance ..................................................................52 Product Capsule: Long-Term Care........................................................................56 Product Capsule: Supplemental Health.................................................................59 Capital and Ratings .................................................................................................61 Life Industry Invested Assets..................................................................................64 Industry Consolidation............................................................................................72 Mutual Insurers and Demutualization...................................................................77 Regulatory Issues .....................................................................................................79 Earnings Model Mechanics .....................................................................................83 Statutory Accounting...............................................................................................85
We would like to thank Patrick Biladeau for his contribution to this report.
likely benefit from a soft rise in rates due to their exposure to the property casualty business. Book values are likely to decline if rates rise due to the negative impact this would have on unrealized investment gains included in book value. In most cases this would not have a negative economic impact, however. Companies remain vulnerable to a flattening of the yield curve, which would hurt earnings for spread products such as GICs, fixed annuities, and UL. While spreads may benefit from a gradual rise in rates (or a parallel shift higher in the yield curve), which would further reduce pressure on minimum crediting rates, a rise in short-term rates resulting in a flatter yield curve would exert downward pressure on spreads. This would hurt companies with significant earnings exposure to spread products such as fixed annuities and GICs, particularly companies lacking an offsetting exposure to improving equity market trends. We think PL, JP, JHF, and MET would be most at risk in the event of a flattening of the yield curve. Pressure from ratings agencies is likely to abate in 2004, increasing capital flexibility, bringing back share buybacks. Lower investment losses and stronger earnings have allowed companies to strengthen their capital position and, in many cases, accumulate excess capital. As a result, we think ratings agencies are likely to become less negative on the sector and could even revise their negative outlook on the sector to neutral in 2004. We think this could benefit the sector in the form of additional share buybacks, ratings upgrades, or the removal of negative outlooks from certain names. Companies we think would benefit most from this include MET, LNC, and PRU. However, capital flexibility could be hurt by higher reserve requirements for no-lapse UL (AXXX) and guaranteed life products, although it appears that these are likely to have a greater impact on reinsurers in the near term. As capital continues to build and trends return to normal, we think companies should reconsider modest dividends and raise yields and payouts. A number of companies have raised their dividend payouts as a result of the reduction in the dividend tax rate in 2003. Still, dividend yields on average for the sector are 1.44% and payout ratios are 22.6% on average, below comparable financials such as banks and thrifts. We think companies should consider further dividend increases as capital flexibility builds to increase their appeal with investors. We expect life insurance industry consolidation to continue to heat up in 2004 as operating trends improve, rating agency pressures lift, and capital pressures diminish. We expect greater capital flexibility in 2004, driven by lower levels of realized investment losses and continued improvements in VA earnings and reduced death benefit expenses. The forces driving consolidation should gradually pressure companies to sell non-core businesses, sell their company, or participate in a merger of equals. We view this as a buyers market and prefer potential buyers to potential sellers, as we expect continued modest premiums awarded to sellers. The combination of buying properties at reasonable prices, gaining scale, and potentially creating better efficiencies should benefit better-positioned buyers over the long term. We think the premier companies in the industry are likely to be awarded with premium valuations as operating conditions continue to improve. While industry P/E and P/BV multiples have recovered from the lows seen in 2002, valuations remain in a tight range. The median life insurer trades at 11.7 times 2004E earnings, with 14 out of 24 companies with P/Es roughly in the 10-12 range. In our view, the best positioned companies are likely to pull away from the pack as they continue to deliver stronger than average sales, earnings, and returns. In particular, companies that we
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believe will receive premium valuations due to their strong market position, scale, and efficiencies include AIG and HIG.
Source: Company reports and JPMorgan estimates. NTM ROE = Next 12 months estimated earnings divided by 9/30/03 book value per share including unrealized gains or losses. JPMorgan ratings: OW=Overweight, N=Neutral, UW=Underweight.
Primer Summary
This primer provides an overview of the life insurance sector and key issues facing the sector. We discuss macro and earnings drivers, success factors, distribution; products, capital, and valuation. Further, the primer addresses investment issues, regulation, consolidation, and sector-specific modeling and accounting issues.
Resource Tools
In the appendices of the report, we have created valuable resource tools covering earnings, distribution, products, and key insurance terms.
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Life insurers have significant exposure to the equity market through their variable annuity and variable life businesses because assets are invested in equitytype funds. The performance of the equity market affects both revenues and expenses for variable products, and affects them in four ways. Fees: Investment performance for the underlying account balances, which are typically invested in equity mutual funds, depends on the performance of the equity market and is a key driver of fee revenues for variable products. Sales: Sales of variable annuities are generally positively correlated in the equity market. Sales are generally weak in a weak equity market, while a recovery in the equity market results in stronger sales (although there is usually a one to two quarter lag before sales pick up following a recovery or slow following an economic downturn). Deferred acquisition costs (DAC): Broker commissions (acquisition costs) are deferred at the time variable annuities are sold, and amortized over the profitable life of the policy. If profitability is weaker than expected due to weakness in the equity market, DAC amortization must be accelerated, resulting in higher expenses. Better than expected equity market experience can result in a positive unlocking or a reduction in DAC expenses, which would benefit earnings. Guaranteed Minimum Death Benefit (GMDB): GMDBs guarantee the policyholder a minimum benefit at death, regardless of the performance of the underlying variable annuity account. Death benefit expenses are higher when customers die and accounts balances are in the money, or below the guaranteed death benefit. Statutory reserves associated with GMDB also need to be increased when account balances decline (due to a weak equity market), which can strain capital. Conversely, GMDB expenses and reserve requirements are lower when the equity market is strong, since fewer accounts are in the money. Companies will be required to establish GAAP GMDB reserves in the beginning of 2004.
The level of interest rates is an important earnings driver for long-tailed products that have embedded interest rates. Long-tailed products that are sensitive to the level of interest rates include whole and term life, life reinsurance, long-term care, supplemental medical, and disability. Investment income for these products tends to be stronger when yields are higher, and lower interest rates generally pressures investment income and profitability for these products.
Spread product earnings generally depend more on the shape of the yield curve than on the absolute level of interest rates. Since assets for spread products are generally tightly matched with liabilities, the absolute level of interest rates does not generally affect earnings for these products, unless rates are so low that it becomes difficult to generate reasonable spreads because investment yields are too low, backing up against minimum crediting rates. However, most states recently approved reductions in minimum crediting rates for newly sold fixed annuities. The shape of the yield curve is more important to spread product earnings since crediting rates generally track short-term rates while investment yields move more closely with intermediateterm rates. In general, the most favorable environment for spread products is rapidly declining interest rates combined with a steep yields curve as crediting rates decline faster than yields. Conversely, the worst environment is a rapidly rising rate environment where the yield curve flattens as crediting rates rise faster than portfolio yields.
Risk Income
Risk income generates about 20% of industry earnings.
Life insurers generate risk or underwriting income by assuming mortality and morbidity risks from individuals. Risk income is generated on life insurance, longterm care, disability, supplemental medical insurance, and reinsurance. The level of benefits that needs to be paid in a given period and the reserves established for future losses determine the benefits ratio (benefits divided by premium income) and drives the underwriting income for the product in that period. Companies use historical data, mortality tables, and loss experience to price risks for these products. Unlike other life insurance products, risk income generally does not depend on macroeconomic factors (although disability claims experience is influenced by the economic climate).
See page 64 for a discussion of life insurance industry investment exposures and page 61 for the impact of credit losses on capital.
We recommend buying equity-market sensitive stocks when the equity market shows signs of improvement: HIG, LNC, AIG, PRU, NFS, PFG, and PNX. These stocks are sensitive to the performance of the equity market due to their earnings from equity-linked businesses such as variable annuity, variable life, brokerage, and asset management. While these companies also have exposure to earnings from other products such as spread products, property/casualty, and health insurance, earnings from equity-linked products often accelerate and decelerate more quickly than other businesses. As a result, improvement or deterioration in the equity market has a major impact on earnings growth and thus valuation and stock price performance. AIG, HIG, NFS, and LNC have considerable exposure to the equity market (roughly 20-40% of earnings exposed to the equity market) through variable products such as variable annuities and variable life. PFG is exposed to the equity market (25% of earnings) through its full-service accumulation pension and asset management businesses.
See page 8 for more detail on the sensitivity of life insurers earnings to the equity market.
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PRU has exposure to the equity market (almost 30% of earnings) through its variable products, asset management, and brokerage businesses.
Several equity market sensitive names appear attractively valued relative to their near-term growth prospects, in our view. Multiples for equity market sensitive names compressed substantially as a result of the 2001 and 2002 equity market declines, although they have recently rallied from their lows. The valuations look attractive in light of their near-term earnings growth relative to their peers.
See page 64 for a fuller discussion of investment losses and other investment related issues.
uy stocks with higher than average credit exposure when credit defaults are improving. Companies such as JHF, MET, MFC, and UNM are seen as credit sensitive due to their large holdings of below investment grade bonds or other risky investments. Heavy realized losses suffered on these riskier investments when the credit market deteriorates reduce net income and can negatively impact capital for these companies. Reduced capital flexibility can result in share buyback programs being put on hold (which reduces EPS growth) or, in extreme cases, issuance of additional equity or other dilutive securities. As credit defaults improve, companies that had suffered substantial investment losses should benefit from increasing capital flexibility and should be able to increase repurchase activity. This should result in a multiple expansion for these companies.
Defensive Names
AFL, JP, PL, RGA, and TMK are defensive names.
Buy stocks with conservative investment strategies and little equity market exposure when markets are troubled and the sector is out of favor. Companies such as AFL, JP, PL, RGA, and TMK generate earnings that are not meaningfully linked to the performance of the equity market, and as such, are likely to deliver relatively strong earnings when the equity market is weak. Similarly, these companies tend to have more conservative than average investment portfolios, characterized by low exposure to below investment grade bonds and riskier asset classes such as equities and partnerships, and have suffered lower levels of realized losses in tough credit markets. While earnings for these companies do not benefit from lower interest rates, defensive companies generally have stronger relative earnings when the economy is weak. While multiples for these names also tend to come under pressure when the equity market is weak, their valuations often do not compress to the same extent as for stocks with credit or equity market exposure. Similarly, valuations for these stocks are not likely to expand as much in the event of a recovery. Currently, we think the defensive names probably do not have as much upside potential as stocks more levered to improving trends. While earnings and valuations for this group held up relatively well in the face of the multi-year equity market decline and severe credit market turmoil, the stocks are likely to underperform other stocks in the group that should benefit from improvements in the equity and credit markets. With the exception of AFLAC, these companies generally have lower than average earnings growth prospects.
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Broad-Based Distribution
Distribution is critical for generating sales, particularly due to intense competition for sales of most life insurance products. Many insurance products are commodity-like, with dozens of companies offering similar products. In order to drive sales in this environment and access the target market, it is important for companies to have superior access to broad-based and multiple distribution channels. Service provided to distributors and wholesalers through the use of technology in-house, such as support personnel, web sites with product information, quick underwriting time and payment of commissions, is also critical.
See page 15 for additional details about life insurance distribution. Also see Appendix VIII for more detail on distribution capabilities of individual companies.
AIG, HIG, NFS, AFL, and LNC have the strongest distribution capabilities, with a solid presence in multiple channels. JHF, MET, and PRU have among the largest captive forces of publicly traded companies and have made progress recently in enhancing this channel, but still have some work to do.
Balancing risk and return in the investment portfolio an important competency for insurers. Since investment income is a key driver of earnings for life insurers, it is important for companies to be able to generate suitable investment yields. However, while taking on additional risk in the investment portfolio is one way to boost returns, investment losses (which are recognized through net income, not net investment income or operating income) can impact earnings and put stress on statutory capital. It is important for insurers to be skilled at taking prudent risks and avoiding substantial investment losses.
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Product mix is an important determinant of investment strategy, as most companies seek to minimize the mismatch between invested assets and product liabilities. The ability to maximize yields is an important competency for many products (such as traditional life, disability and reinsurance), while spread management is important for other products (fixed annuities, GICs and universal life). While its aggressive investment style led to high levels of realized investment losses in 2001 and 2002, JHF is one of the savvier investors, generating higher than industry average yields over the long term. AFL, one of the most conservative investors in the industry, has generally had the best loss experience. AFL does not generally invest in below investment grade securities and also has limited exposure to equities or other riskier asset classes.
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Source: JPMorgan estimates. Note: Ratings are relative to other companies in our coverage universe.
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Distribution
Highly saturated markets and commoditization of insurance products have made distribution a crucial success factor in the life market. Competition in most insurance markets is highly intense, with a large number of companies offering similar products. While having the right products is important, product design has become less important than distribution since new product features can be easily copied. Companies need to have superior access to multiple distribution channels in order to drive sales in this environment, but distribution channels have become increasingly cluttered and difficult to penetrate. Distribution focus over the past 20 years has been broadened to include broker dealers and banks, in addition to the more traditional agent channel. In conjunction with the shift in product focus to retirement savings from protection products, the greatest growth opportunities exist in the broker/dealer (a growing channel) and bank (less penetrated) channels. Wholesalers (intermediaries between insurers and distributors) have become increasingly important in penetrating these alternative channels.
See Appendix VIII on page 94 for detailed information regarding distribution capabilities for individual companies.
Independent Financial Planners: Independent financial planners are small independent advisory firms that sell a full range of investment and insurance products. This channel typically receives the most aggressive commissions and generally focuses on selling products with some form of guarantee.
Hartford has been particularly successful in the investment dealer channel, ranking first in the sale of variable annuities, benefiting from its strong brand name, service orientation, and extensive wholesaler operation. Other companies that have had success in penetrating this channel include AIG, National Financial Partners, American Skandia/Prudential (in the financial planner channel), and Manulife.
Banks
Banks are less penetrated and offer solid growth prospects, but offer challenges in training and motivating distributors. A key challenge in penetrating the bank channel is that life insurers, rather than banks, must train bank employees to sell their products. Annuities are the most widely sold life insurance product through banks because fixed annuities are simple products (like a tax-deferred CD) that are relatively easy to train people to sell. Variable annuities are typically sold through the broker/dealer subsidiaries of banks, as the relative complexity of the product makes it more difficult to motivate bank tellers to sell. Life insurance is also difficult to sell through banks due to its complexity and the need for a life insurance license. The bank channel accounts for roughly 20% of total annuity industry sales, up from 16% three years ago. Total annuities sold through banks in 2002 grew 29% from 2001 to $49.1 million. Major banks offering insurance include BankOne and Citigroup. AIG, Nationwide, and Hartford have had success in selling products through the bank channel.
Figure 1: Banks Represent an Increasingly Important Distribution Channel for Annuities
$ in billions
$60 $50 $40 ($ billions) $31.0 $30 $20 $10 $0 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 9M02 9M03
Source: The Kehrer Report and JPMorgan calculations.
$49.1 $38.1 $26.4 $18.1 $12.3 $13.5 $14.2 $17.2 $19.3 $19.7 $37.1 $38.5
Smaller insurers often rely on third-party marketers to drive sales through banks. Companies that do not have direct relationships with banks typically use third-party marketers such as Independent Financial, Essex (owned by John Hancock), and Talbot. Relationships typically are not exclusive, and third-party marketers usually represent several insurance companies. Most of the largest life insurance company sellers through banks primarily sell directly rather than using third-party marketers. Sales of
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fixed annuities through third-party marketers in 2002 (up 32.7%) experienced significant growth (slightly less than the overall market, which grew 34.1%). Sales of annuities through third-party marketers represent about 40% of fixed annuity sales.
Agent-Led Channels
Captive and independent agents remain important for distribution of insurance products, although they are relatively mature and growing slower. Captive agents are full-time employees, compensated primarily with sales commissions and certain employment benefits and cannot sell the products of other insurance companies. Mutual insurers often rely on captive agents to distribute their products. The channel can be expensive due to salary costs, benefit payments, and frequent agent turnover, although companies have driven down costs for captive agents by consolidating sales offices and revising compensation practices. Independent agents are able sell the products of more than one insurance company, or different types of insurance, ranging from life to auto insurance. They are not employees of the firms whose products they sell. Compensation is determined on the basis of sales commissions, and employee benefits (health care, pensions) are not typically provided to these agents. This channel is a major seller of many products, including whole, term and universal life, fixed and variable annuities, group life, disability insurance, and long-term care. Since agents sell products from multiple insurers, having a compelling product offering and excellent service (through broker general agents or BGAs) is essential to succeed in this channel. Competitive commissions and quick turnaround of policies are also important in this channel.
Direct Channels
The arrival of the Internet has increased the potential of the direct channel, but the high touch nature of insurance products presents a challenge. Highly commoditized and inexpensive life insurance products are more frequently being sold directly to consumers by direct mail, telephone, and the Internet. Products like term life and supplemental insurance are among the most frequently sold. While annuities are marketed and sold over the Internet, the channel has yet to realize significant sales, partially due to the products complexity and substantial investment requirements. As consumers become more familiar with shopping online, the Internet channel is expected to grow. However, given the importance of direct contact and advice in the sale of insurance products, sales through the direct channel are likely to remain relatively small.
Table 4: Summary: Distribution Channel Matrix
Products Channel Sold Agent Led Life, Annuities, Supplemental Investment Dealer Annuities, GICSs Bank Fixed Annuities Direct Term Life, Supplemental
Source: JPMorgan.
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Historical Perspective
Changes in business mix and distribution strategies have fundamentally changed the life insurance industry over the past decade. The shift from protection-oriented products to investment-oriented products has made insurers modestly less interest rate sensitive and more exposed to the equity market (with roughly 30% of life insurance exposed to the equity market).
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1 8 .0 A v e ra g e = 1 3 .9 1 6 .0
1 4 .0
1 2 .0
1 0 .0
8 .0
6 .0 1 /9 4 1 /9 5 1 /9 6 1 /9 7 1 /9 8 1 /9 9 1 /0 0 1 /0 1 1 /0 2 1 /0 3 1 /0 4
A c tu a l P /E
Source: FactSet.
Life insurance P/E ratios generally move in line with the outlook for earnings growth for the sector. In general, the higher the earnings growth prospects for the company, the higher P/E ratio it will be awarded by investors. This relationship between P/E and earnings growth has been solid over time, with P/Es expanding as earnings growth improves and contracting as earnings growth slows. Companies should generally trade at a P/E roughly in line with earnings growth (or a slight premium), and companies with consistently high earnings growth should be awarded a premium P/E valuation.
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19.0 Price / Earnings Ratio 2003 AIG NFP 15.0 PL JHF NFS 11.0 (-1.1%, 11.5) UNM (-14.1%, 9.5) TMK PFG JP 13.0 DFG RGA SFG MET HIG
17.0
9.0
7.0 5.0%
9.0%
13.0%
17.0%
21.0%
25.0%
The life insurance industrys correlation with interest rates, once strong, has declined over time. From 1994 to 1999, the industry had a relatively strong correlation with rates, with valuations contracting when interest rates rose. This relationship appears to have begun to break down after 1999, and after 2001 there appears to be little remaining correlation between life industry valuations and interest rates.
Figure 4: Life Industry's Correlation with Interest Rates Declining
20.0
18.0
Period 3 Period 1
R =0.69
2
R2=0.36
Period 4
R2=0.11
16.0
14.0
12.0
10.0
Period 2
R2=0.81
8.0 1/94 1/95 1/96 1/97 1/98 1/99 1/00 1/01 1/02 1/03 1/04
Actual P/E
Predicted P/E
Source: FactSet.
Industry P/BV multiples have also recovered from their lows. The life industry currently trades at 1.37 times book value (excluding FASB 115), a discount to the long-term average multiple of 1.8 times. Multiples of book values excluding FASB 115 (which marks to market gains on investment securities) are more representative, we believe, since they exclude large interest-rate related gains on investments that have inflated BVs and thus understated P/BV multiples for many insurers. We expect multiples for the industry to approach historical averages as ROEs improve due to better performance of equity-linked products and as realized investment losses remain low.
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1.9 SLF 1.5 PRU 1.1 PLFE 0.7 MNY PNX UNM NFS PL MET AMH PFG SFG
HIG TMK
0.3 0.5%
2.5%
4.5%
6.5%
8.5%
10.5%
12.5%
14.5%
16.5%
18.5%
Embedded Value
While generally not used by U.S. insurers, embedded value is a widely followed insurance valuation metric outside of the United States. To estimate embedded value, companies add an estimate for the value of in-force insurance business (present value of future profits) to adjusted shareholders equity. The value of in-force insurance business is estimated by valuing the stream of profits expected from the life insurance
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business in the future, adjusted for the regulatory capital required to back the business. Key inputs into the value of in force business include the regulatory capital required for the business, an appropriate discount rate (usually a government bond yield plus a risk premium), and a tax rate. Embedded value is difficult to calculate for U.S. companies, since the companies do not typically provide much of the information needed to do the calculation. A large number of inputs are needed to estimate the present value of future profits, including a risk discount rate, investment return assumption, surrender and lapse experience, taxes, mortality/morbidity experience, and other items. Embedded values are also difficult to compare from company to company since they rely on a large number of assumptions that may differ from company to company.
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Variable annuity earnings are largely tied to the performance of the equity market. Earnings are driven by fees on policyholder account balances, most of which is invested in equity-type mutual funds, so that account balances and fees generally rise with the equity market. Sales also tend to be stronger when equity market performance is strong although sales have historically tended to lag movements of the market by almost a quarter. In addition to higher revenues, strength in the equity market also results in lower deferred acquisition cost (DAC) and guaranteed minimum death benefit (GMDB) expenses for variable annuities.
Key Statistics
Return on Equity: 15% or higher in normal environment, depending on scale and efficiencies Forecast Long-Term Earnings Growth Rate: 10-12% Typical Commission Structure: 7% on new sales
Product Description
The recent reduction in dividend taxes potentially reduces the appeal of variable annuities relative to mutual funds, although the tax cut does not appear to have had a major impact on sales in the near term. See page 81 for further discussion.
Variable annuities are insurance contracts that function as tax-deferred mutual funds with a death benefit, and many products offer living benefits. Variable annuities offer a range of options that invest in mutual funds (stocks, bonds or money market funds) or a fixed rate option. The value of the annuity depends on the performance of the investment options chosen. The customer does not pay taxes on the income and investment gains on the invested assets until the contract is annuitized or withdrawn, at which point income is taxed at the ordinary rate. Customers must typically pay a surrender charge, which generally begins at 7% and declines over time, if funds are withdrawn before the seventh year. Customers use VAs as the primary source of retirement savings (in the case of qualified VAs, typically 403(b)s or 457 plans in the case of teachers and hospital employees or government employees, respectively) or to supplement retirement savings or 401(k) plans (non-qualified). The IRS assesses a 10% penalty, in addition to tax, if funds are withdrawn from a variable annuity before age 59 .
accumulation benefits (GMWBs). Customers must also pay fees for the underlying mutual funds in which the assets are invested (40-150 basis points), although these fees flow through to the asset manager managing the funds. The performance of the equity market is an important determinant of the level of assets under management and fee revenue. The customer bears the investment risk on the assets, so the business can be supported with a lower reserve level than for fixed products (where the insurer bears the risk), generating a higher ROE. DAC and GMDB expenses, both affected by the performance of the equity market, are two key drivers of VA profitability. DAC represents acquisition costs (primarily commissions) that are capitalized when an annuity is sold and amortized over time. With the equity market declines of 2001 and 2002, higher DAC expenses have hurt earnings for VAs because actual profits fell short of original expectations requiring DAC to be accelerated. The stronger equity market has helped to relieve DAC pressures, as product profitability has been improving as the equity market has climbed. GMDBs guarantee the policyholder a minimum benefit at death, regardless of the performance of the underlying variable annuity account. Death benefit expenses are higher when customers die and accounts balances are in the money, or below the guaranteed death benefit. Statutory reserves associated with GMDB also need to be increased when account balances decline (due to a weak equity market), which can strain capital. Conversely, GMDB expenses and reserve requirements are lower when the equity market is strong, since fewer accounts are in the money. GMDB has more of an ongoing effect on earnings and affect SAP and GAAP results. The key issues with GMDB are (1) amount of assets in the money, or account balances that are below the guaranteed minimum death benefit; (2) reinsurance purchased; and (3) statutory reserves established. NAR, net amount at risk, is an indicator used to quantify the portion of variable annuity assets covered by a guaranteed minimum death benefit that is "in the money," and retained NAR is the amount of exposure, which reinsurance is not able to cover. Retained NAR, the risk retained after reinsurance, is the key metric of an insurers exposure to GMDB. GMDB expenses are incurred when policyholders holding a GMDB die with their account value below the guaranteed value. Charges to establish GAAP reserves for VA GMDB in early 2004 are expected to have a modest impact on net earnings and a minimal ongoing impact. The AICPA statement of position (SOP) regarding reserves for GMDB is on track for adoption in the beginning of 2004. The SOP requires companies to establish GAAP reserves against GMDB exposure (where many companies previously only maintained statutory reserves), and companies will likely take charges early in 2004 to establish these reserves. The net impact should be relatively modest, and the charges will not be included in operating income.
Sales of VAs through investment dealers have grown quickly, although this channel is becoming increasingly cluttered and competitive. Larger
players dominate the wirehouse (large securities firms, generally based in New York) and regional broker dealer (Edward D. Jones, A.G. Edwards) channel, with smaller players struggling to gain shelf space due to competition, high cost, and high quality of service required to effectively compete in this channel. Independent financial planners represent a less centralized channel, and generally offer products with more specialized features and have the most aggressive commissions.
See page 15 for a full discussion of distribution for the life insurance industry.
Banks represent a channel with good growth potential, but have proven difficult for VA companies to penetrate. A few companies have had considerable success in generating sales of variable annuities through banks, although sales through this channel remain challenged by the lack of in depth product knowledge from bank personnel. Captive agents remain an important distribution channel, although it is losing ground to alternative channels. Although captive agents remain an important channel for distribution of variable annuities, it is not growing as quickly as alternative distribution channels. The direct channel, while inexpensive, is likely to remain a relatively small contributor to sales. Direct sales have not been a channel that has performed well relative to the other VA distribution channels, due to the complex nature of the product and the need for it to be actively sold.
1996 3Q03
Source: VARDS.
Concentrated Market
The level of sales and assets are both relevant measures of a companys standing in the VA market. New sales indicate the companys near-term business momentum, and are key to building a solid base of VA assets in the long term. The level of assets, however, is a more important determinant of VA earnings power. Despite the large number of players, the VA market is becoming increasingly concentrated. While there are over 50 companies writing variable annuities, the top 10 VA companies account for over half of VA sales, and the top 25 companies account for close to 90% of industry sales. The largest sellers of VAs with the strongest distribution networks have been winning market share, increasing the concentration of
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the market. Hartford, the top seller of variable annuities, has enjoyed market share gains recently due to strong sales of its Principal First feature, a guaranteed minimum withdrawal benefit (GMWB).
Table 5: Individual Variable Annuity New Sales (Gross Sales Less Internal Transfers)
$ in millions 3Q02 3Q03 Rank Rank Company 2 1 6 5 3 10 7 8 11 13 1 2 3 4 5 6 7 8 9 10 Hartford Financial TIAA-CREF AXA Group MetLife/NEF/Gen Am AIG/American General/SunAmerica Pacific Life Insurance Company ING Group of Companies Prudential/Skandia Lincoln National Manulife Financial Top 10 Companies Top 25 Companies Total Companies
Source: VARDS and JPMorgan calculations.
3Q02 2,404.8 3,350.8 1,481.2 1,505.6 1,844.5 1,032.9 1,388.3 1,257.8 1,006.0 883.0 16,154.9 24,710.1 28,095.5
3Q03 3,974.4 3,056.8 2,894.3 2,518.5 2,326.7 1,566.9 1,550.9 1,257.8 1,057.7 981.4 21,185.4 29,376.6 31,339.9
% Change 65.3% -8.8% 95.4% 67.3% 26.1% 51.7% 11.7% 0.0% 5.1% 11.1% 31.1% 18.9% 11.5%
3Q02 Mkl. Sh. 8.56% 11.93% 5.27% 5.36% 6.57% 3.68% 4.94% 4.48% 3.58% 3.14% 57.50% 87.95% 100.00%
3Q03 Mkt. Sh. 12.68% 9.75% 9.24% 8.04% 7.42% 5.00% 4.95% 4.01% 3.37% 3.13% 67.60% 93.74% 100.00%
bp Change 412 (217) 396 268 86 132 1 (46) (21) (1) 1,010 579 0
9M02 6,902.5 9,301.6 4,408.9 4,499.4 5,808.8 3,034.9 4,248.4 3,738.3 3,071.3 2,898.0 47,912.1 72,543.2 82,901.3
9M03 11,655.9 9,583.4 8,129.4 7,269.2 5,949.4 4,626.3 4,335.2 3,771.2 2,771.8 3,062.2 61,154.0 87,470.8 93,109.6
% Change 68.9% 3.0% 84.4% 61.6% 2.4% 52.4% 2.0% 0.9% -9.8% 5.7% 27.6% 20.6% 12.3%
Top variable annuity companies also have been increasing their share of industry assets. The largest 10 VA companies have over 70% of industry assets, and the largest 25 companies control 94% of industry assets. Companies with a larger base of assets have the advantage of economies of scale and lower expenses, so the increasing concentration of industry assets is likely to benefit the larger players at the expense of more marginal competitors. TIAA-CREF, which sells primarily qualified annuities, has a significant 28.8% share of the industry assets with and $253 billion in assets at the end of the second quarter of 2003. Among non-qualified annuity players, Hartford and AIG have the largest market shares with 8.2% and 6.2% of industry assets, respectively.
Table 6: Individual Variable Annuity Assets Under Management
$ in millions 9/30/02 Rank 1 2 3 5 7 4 6 8 9 10 9/30/03 Rank Company 1 2 3 5 4 6 7 9 8 10 TIAA-CREF Hartford Financial AIG/Amer. Gen./SunAmerica Lincoln National AXA Group Prudential/Skandia ING Group/ReliaStar/Aetna Nationwide MetLife/NEF/Cova/GenAm IDS Life Top 10 Companies Top 25 Companies Total Industry Assets
Source: VARDS and JPMorgan calculations.
9/30/02 Assets 225,088 59,135 48,353 34,385 29,417 34,918 32,487 29,145 22,695 22,057 537,682 701,419 756,734
9/30/03 Assets 260,725 76,894 58,671 39,972 40,831 38,877 38,737 35,161 36,684 27,666 654,217 856,416 909,761
% Change 15.8% 30.0% 21.3% 16.2% 38.8% 11.3% 19.2% 20.6% 61.6% 25.4% 21.7% 22.1% 20.2%
9/30/02 Mkt. Sh. 29.74% 7.81% 6.39% 4.54% 3.89% 4.61% 4.29% 3.85% 3.00% 2.91% 71.05% 92.69% 100.00%
9/30/03 Mkt. Sh. 28.66% 8.45% 6.45% 4.39% 4.49% 4.27% 4.26% 3.86% 4.03% 3.04% 71.91% 94.14% 100.00%
6/30/03 Assets 253,580 72,184 54,946 38,869 37,931 37,854 37,563 34,359 34,262 26,700 628,247 822,137 880,091
Seq % Change 2.8% 6.5% 6.8% 2.8% 7.6% 2.7% 3.1% 2.3% 7.1% 3.6% 4.1% 4.2% 3.4%
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$110
1,400
1,200
400
$10
200
-$10
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003E
Industry fund flows deteriorated with the weak equity market but appear to be recovering along with the equity market. Fund flows are an important indicator of the underlying health of the VA business. VA fund flows, defined as new deposits less withdrawals, declined to $19.4 billion in 2002 from their peak of $52.1 billion in 1999. This is due both the weaker sales and an increase in withdrawals, both driven by consumer concerns about the equity market. Fund flows appear to be back on track in the second quarter of 2003, nearly tripling from second quarter 2002 levels to $13.9 billion, boosted by the stronger equity market.
Figure 9: Fund Flows: Down from Peak Years, but Getting Stronger
$ in billions
60.0 50.0
41.4 49.1 52.8 52.1
32.8
35.3
19.4 15.5
1995
1996
1997
1998
1999
2000
2001
2002
9M02
9M03
See page 79 for further discussion of regulatory issues affecting the life insurance sector.
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Key Statistics
Return on Equity: 8-13% Forecast Long-Term Earnings Growth Rate: 9-11% Typical Commission Structure: 7% of deposits
Product Description
Fixed annuities are an investment vehicle that guarantees a fixed crediting rate on the account balance (either an annual rate or a fixed rate for the duration of the contract). Traditional annuities guaranteed a rate for one year, but insurers more recently have been emphasizing multi-year products (3-,5-, 7- or 10-years), which guarantee a set rate for multiple years and which are easier to manage from an asset/liability perspective. Customers use FAs as the primary source of retirement savings (in the case of qualified FAs) or to supplement retirement savings (non-qualified). The IRS assesses a 10% penalty, in addition to tax, if funds are withdrawn from a fixed annuity before age 59 . Retirees seeking stable income from their investment portfolio are the primary buyers of fixed annuities. Insurers protect themselves from early withdrawals through surrender charges, which customers must pay if they withdraw their funds before five to seven years and typically begin at 5-7% and decline over time. Fixed annuities also have a market value adjustment (MVA) feature that also protects companies against early withdrawals by adjusting the value of a withdrawal or surrender according to changes in interest rates. The MVA may have a positive or negative impact on the value of the withdrawal amount depending on the level of interest rates. Fixed annuities can be compared to a higher yielding, less liquid CD.
interest rates does not generally affect earnings for fixed annuities. The shape of the yield curve is more important to spread product earnings since crediting rates generally track short-term rates while investment yields move more closely with intermediateterm rates. The absolute level of interest rates is only relevant for spread products when investment yields approach state-mandated minimum crediting rates on a given product. However, most states recently approved reductions in minimum crediting rates for fixed annuities (to 1.5-2% from 3%), the main insurance product with minimum rates. Persistency is another key driver of fixed annuity profitability. Insurers are exposed to rising withdrawals when interest rates are climbing, as policyholders withdraw their funds to seek higher-yielding alternatives. MVAs protect insurers against heavier withdrawals, although low persistency generally still hurts FA profitability. In the case of much heavier than expected withdrawals, companies may be forced to unlock DAC (deferred acquisition costs) associated with FAs to reflect the lower profitability. Companies are partially protected against early withdrawals by surrender charges and MVA features.
2002
Other 7% Direct Response 1% St ockbrokers 7%
Banks 36%
Source: LIMRA.
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2002 Sales 11,189.7 6,931.1 6,243.3 5,130.6 4,787.2 4,409.4 4,026.2 3,962.0 2,933.0 2,861.6 103,300.0
Market Share 10.8% 6.7% 6.0% 5.0% 4.6% 4.3% 3.9% 3.8% 2.8% 2.8%
Market Size
Sales of fixed annuities more than tripled over the period from 1998 to 2002 to $103.8 billion in 2002, driven by consumer demand for fixed returns as a result of the sharp equity market decline. The most recent sales from the first quarter of 2003 were $23.9 billion, 8.1% over the $22.1 billion from the first quarter of 2002.
Figure 11: Total Fixed Annuity Sales from 2000 to 3Q03
$ in billions
120
103.8
Source: LIMRA.
Outlook
A parallel shift in the yield curve should allow companies to increase fixed annuity sales, although spreads and sales may be hurt if the yield curve flattens. The rise in rates in the second half of 2003 and regulatory relief (lowering minimum crediting rates) removed pressure against minimum rates and allowed companies to increase their sales of fixed annuities from
31
depressed levels in the first half of 2003. A parallel rise in rates would provide further room above minimum rates and further support sales. Still, spreads may come under pressure in the event of sharply higher rates accompanied by a flattening of the yield curve, which may occur sometime in 2004. If the yield curve flattens significantly, preventing companies from achieving targeted spreads, companies may pull back on sales of fixed. If equity market performance remains solid, consumer preference is likely to continue to shift to variable products, resulting in weaker sales and higher withdrawals for fixed annuities.
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Key Statistics
Return on Equity: 10-12% Forecast Long-Term Earnings Growth Rate: 9-11% Typical Commission Structure: 7-9% of deposits
Product Description
Equity indexed annuities guarantee a fixed return and an additional return based on the performance of an equity market index (usually the S&P 500 Index). The return credited to the policyholder based on the index (known as the participation rate) can be based on a variety of crediting methods, including a percentage of the maximum anniversary value of the index, the annual performance of the index, or the multi-year average performance. The amount credited based on the indexs performance is generally capped at about 7-8%. As with other annuities, the IRS assesses a 10% penalty, in addition to tax, if funds are withdrawn from a variable annuity before age 59 .
lack of access to NASD-licensed distribution or appropriate technology or service required to participate in that market. The product typically is sold by agents who are not licensed to sell variable annuities and mutual funds but want to sell equity-linked products.
3Q02 981.6 159.5 407.7 15.0 737.5 47.7 116.4 73.2 31.0 142.7 2,712.3 3,296.3 3,324.4
3Q03 920.6 391.7 365.1 160.7 159.9 130.5 104.1 102.1 91.0 89.3 2,515.1 2,899.3 3,169.1
% Change -6.2% 145.5% -10.5% 971.2% -78.3% 173.7% -10.6% 39.6% 193.8% -37.4% -7.3% -12.0% -4.7%
3Q02 Mkt. Shr. 29.53% 4.80% 12.27% 0.45% 22.18% 1.43% 3.50% 2.20% 0.93% 4.29% 81.59% 99.15% 100.00%
3Q03 Mkt. Shr. 29.05% 12.36% 11.52% 5.07% 5.05% 4.12% 3.28% 3.22% 2.87% 2.82% 79.36% 91.49% 100.00%
bp Change (48) 756 (74) 462 (1,714) 268 (22) 102 194 (147) (222) (767) 0
9M02 2,295.5 462.2 1,186.2 29.0 1,664.8 118.3 320.4 182.4 93.9 334.7 6,687.4 8,144.5 8,244.8
9M03 3,309.2 990.4 820.5 354.1 508.2 395.9 275.9 342.8 209.0 381.2 7,587.2 9,093.0 10,135.3
% Change 44.2% 114.3% -30.8% 1121.1% -69.5% 234.7% -13.9% 87.9% 122.6% 13.9% 13.5% 11.6% 22.9%
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35
Key Statistics
Return on Equity: 10-12% Forecast Long-Term Earnings Growth Rate: 8-10% Typical Commission Structure: Varies
Product Description
Guaranteed investment contracts (GICs) are fixed rate investments, backed by the general account offered by insurance companies that guarantee a rate of return on assets for a fixed period and payment of principal and accumulated interest at the end of the period. GICs can be seen as an institutional fixed annuity. GICs are typically used to fund defined contribution plan stable value funds and generally have terms of three to five years. Synthetic GICs are GICs backed by the separate account. GICs are generally purchased by qualified investors such as defined benefit plan sponsors. They are often used to back a stable value retirement fund options. Funding agreements (FAs) are large (generally over $100 million) investment contracts, similar to bonds, sold to non-qualified fixed income investors. Segments of the funding agreement market include European Medium Term notes (EMTNs), Global Medium Term Notes (GMTNs), and money market. Companies have also begun selling retail notes backed by funding agreements, which are sold in denominations as small as $1,000 and maturities ranging from two to 10 years and which are not as capital intensive as funding agreements. Funding agreements are purchased by institutional fixed income investors, both domestic and international. Money market funds purchase about 20% of funding agreements issued.
36
Outlook
Earnings of GICs and funding agreements should benefit in the near term from the steep interest rate environment, although in the long term, competition and modest demand are likely to limit the markets growth.
37
Sales of both GICs and funding agreements are likely to remain modest in the near term, driven by intense pricing competition and the low interest rate environment. Demand may also be negatively impacted by a consumer shift out of stable value funds and fixed-return options into equities. Earnings for GICs and funding agreement are vulnerable to a flattening of the yield curve, although a parallel rise in rates could help. GIC and funding agreement earnings generally benefit from a steeper yield curve, and earnings for these products would likely suffer in the event of a yield curve flattening. Retail note programs, a relatively new product, have substantial growth potential. While still relatively small, funding agreement-backed retail note programs represent a potential growth market for funding agreements. John Hancock and Protective Life currently offer retail notes.
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Key Statistics
Return on Equity: 10-12% Forecast Long-Term Earnings Growth Rate: 8-11% Typical Commission Structure: 80-90% of first-year premiums, sometimes in addition to a percentage of asset management fees.
Product Description
Capital requirements for nolapse guarantees for UL will increase under Regulation AXXX. See page 99 for more details on AXXX.
Universal life is permanent life insurance that accumulates a cash value at a credited interest rate (which is generally reset periodically by the insurer). Unlike traditional whole life insurance, UL allows the policyholder the flexibility to change the death benefit and the timing and amount of premiums. In addition the cash account is not credited a fixed rate but a rate that varies with interest rates, subject to a 3-4% minimum rate. UL is also sold as second-to-die or survivorship policies, which are less expensive joint policies paying a death benefit in the event of the death of the second of two insureds. Such policies are typically used in estate planning. Universal life appeals to more conservative consumers who favor fixed returns.
cases, driving down operating costs as a percentage of premiums is important for generating earnings growth for UL.
Leading Players
New York Life, ING, Jefferson Pilot, and Aegon are among the largest sellers of universal life. Among our coverage companies, AIG, Jefferson Pilot, Manulife and MetLife are among the largest sellers of universal life.
40
Key Statistics
Return on Equity: 3-8% Forecast Long-Term Earnings Growth Rate: 3-4% Typical Commission Structure: 80-100% of the first-year premiums.
Product Description
Whole life is permanent insurance with a level annual premium over the life of the policy and a fixed death benefit. Whole life can be used as a savings vehicle since policies accumulate a cash balance related to premiums and a fixed interest crediting rate. Whole life policies are typically participating, where the policyholder shares in the profits of the policy and are paid dividends in addition to fixed crediting rates. Since returns are fixed, the product appeals to more conservative consumers. Many policies in force today were purchased at a time when no other types of insurance were available.
41
42
Key Statistics:
Return on Equity: 9-11% Forecast Long-Term Earnings Growth Rate: 5-7% Typical Commission Structure: The first-year commission for term life insurance is usually 50% of the first years premium. The second- through 12th-year commission is usually 35% of the annual policy premium.
Product Description
Term life provides life coverage for a defined period of time with no cash accumulation features or other benefits once the term expires. The policyholder has the option to renew the coverage at the end of the term, but if coverage lapses no payment is made to the insured in the event of death. Additionally, if the customer does not die in the term covered by the policy, beneficiaries receive nothing. The premiums for term life are substantially less than those of permanent life (whole, universal, variable life) for the same face amount of coverage, although upon renewal premiums increase to reflect the beneficiarys age and higher mortality risk. The most popular type of term life insurance is level term, which has a fixed premium throughout the term of the contract. Because of the lower premiums for a given face value (compared with permanent insurance), term life appeals to several groups: middle to lower income families and younger families, who prefer the lower prices, and sophisticated, affluent individuals who prefer to hold their investment portfolios separate from insurance may also prefer less expensive term life to investment-oriented policies.
this business. Companies that are better at assessing risk and underwriting profitable risk generally should have lower benefits expenses relative to premiums than other companies. Although less than other types of insurance, term life is becoming increasingly capital intensive, depressing returns. Regulation XXX increased the level of capital that must be held to back term life policies. While the reserves required for a term life policy are less than for a comparable whole or universal life policy, the higher level of capital required to back a term life liability reduces the return that can be earned on term life, generally limiting potential return to about 10%.
44
Key Statistics
Return on Equity: 11-14% Forecast Long-Term Earnings Growth Rate: 9-12% in normal equity market Typical Commission Structure: 50% of first year premiums; second- through 12thyear commission is usually 3-5% of annual premiums.
Product Description
Variable life (VL) has set premiums over the life of the policy, whereas variable universal life (VUL) allows for flexible premiums and death benefits. For the purposes of this report we refer to both types of policies as VL.
Variable life (VL) is a permanent life policy where the policyholder can choose to invest the cash balance of the policy in equity and fixed income fund options. The benefits and cash values provided by the policy depend on the performance of these investments. VL is often used for retirement planning because it offers a range of investment options, as well as the ability to access the cash balance through loans. VL policies, in general, and survivorship (second-to-die) policies, in particular, are used as an estate-planning tool. VL is targeted at wealthy, sophisticated customers who both have a need for and understand the products many complex features. The primary consumers of variable life products have been middle-aged consumers interested in retirement savings and tax accumulation benefits. VL also appeals to consumers with large estates that are concerned with estate-planning issues and wealth transfer.
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Underwriting discipline is another driver of variable life profitability. Since death benefits are the most substantial expense associated with variable life policies, skillful underwriting of this mortality risk is one of the main determinants of profitability for this business. Companies that are better at assessing risk and underwriting profitable risk generally should have lower benefits expenses relative to premiums than other companies.
46
Top players in VL by assets appear to be losing share to newer players. As with variable annuities, earnings for variable life are a function of assets, not sales. Traditional players (Prudential, AXA, Kemper) maintain a majority of the assets under management in the market despite the rising sales of the newer entrants to the VL market. Asset share for all three companies appears to be declining, however, as companies generating stronger sales take share in the market. Among the key drivers of VL asset growth are persistency, fund flows (new sales less surrenders), and market performance.
Table 11: Variable Life Insurance Company Assets and Asset Market Share
$ in millions 09/30/02 09/30/03 Rank Rank Company 1 2 3 4 7 6 8 NA 9 5 1 2 3 4 5 6 7 8 9 10 Prudential AXA Financial Kemper Investors Life Nationwide/Provident Mutual MetLife/New England/GenAm John Hancock Hartford Financial Services Merrill Lynch Pacific Life IDS Life Top 10 Companies Total Assets
Source: Tilinghast -Towers Perrin and JPMorgan calculations.
09/30/2002 Total Asset Assets Mkt.Sh. 12,569.0 9,186.0 6,506.0 5,108.0 3,708.0 3,993.0 3,444.0 NA 3,127.0 5,040.0 52,681.0 72,823.0 17.26% 12.61% 8.93% 7.01% 5.09% 5.48% 4.73% NA 4.29% 6.92% 72.34% 100.00%
09/30/2003 Total Asset Assets Mkt.Sh. 14,788.0 9,982.0 6,589.0 6,480.0 4,765.0 4,593.0 4,265.0 3,906.0 3,823.0 3,494.0 62,685.0 88,267.0 16.75% 11.31% 7.46% 7.34% 5.40% 5.20% 4.83% 4.43% 4.33% 3.96% 71.02% 100.00%
% Chg. TOTAL Assets 17.7% 8.7% 1.3% 26.9% 28.5% 15.0% 23.8% NA 22.3% -30.7% 19.0% 21.2%
Historical VL Sales
$ in millions
$ 8,000 $ 7,000 $ 6,000 $ 5,000 $ 4,700 $ 3,800 $ 3,250 $ 3,000 $ 2,000 $ 1,000 $0 1996 1997 1998 1999 2000 2001 2002 9M 2003 $ 1,771 $ 6,975 $ 5,900 $ 5,400
Historical VL Assets
$ in billions
$100 $90 $80 $70 ($ billions)
$ 4,000
$88.3
($ millions)
$60 $50 $40 $30 $20 $10 $0 1996 1997 $30.8 $40.5
$ 4,000
$52.4
1998
1999
2000
2001
2002
9/30/03
48
Key Statistics
Return on Equity: 10-14% Forecast Long-Term Earnings Growth Rate: 4-6% Typical Commission Structure: Commissions are generally paid on a sliding scale, with a commission of about 10% paid for the first $10,000-15,000 in premiums, declining with the size of the case to about 0.5% for cases above $1,000,000.
Product Description
Group life is sold to corporations, professional societies, unions, and other organizations to provide life insurance and other disability and extended benefits to their employees or members. Group life can either be offered as a term policy (representing about 95% of all group life policies), or as traditional whole life, universal life, and variable-universal life. Group life plans can also offer additional features such as survivorship and disability benefits, and these plans can be purchased on a participating or nonparticipating basis. Corporate-owned life insurance (COLI) and bank-owned life insurance (BOLI) is insurance taken out on employees but with the corporation or bank named as beneficiary. COLI and BOLI are often used to fund post-retirement benefits. The primary buyers of group life are large companies and professional associations with more than 5,000 employees or members. This highly penetrated segment of the market accounts for the largest portion of premiums written in term of dollars. Small to mid-scale business and organizations represent a much smaller portion of group life business, but this segment is much less penetrated and represents a growth opportunity in this market.
risk generally should have lower benefits expenses relative to premiums than other companies.
Direct 20%
Career Agents 3%
Other 42%
FY 2000 5,304.1 3,000.4 2,226.4 1,205.8 906.2 970.2 741.5 1,144.1 625.7 577.2 16,701.4 27,067.6
FY 2001 6,250.3 3,253.6 1,831.3 1,767.9 1,364.4 996.4 974.0 913.4 693.7 626.3 18,671.4 28,225.8
% Change 17.8% 8.4% -17.7% 46.6% 50.6% 2.7% 31.4% -20.2% 10.9% 8.5% 11.8% 4.3%
2000 2001 Mkt. Shr. Mkt. Shr. 19.60% 11.08% 8.23% 4.45% 3.35% 3.58% 2.74% 4.23% 2.31% 2.13% 61.70% 100.00% 22.14% 11.53% 6.49% 6.26% 4.83% 3.53% 3.45% 3.24% 2.46% 2.22% 66.15% 100.00%
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Key Statistics
Return on Equity: 8-12% Forecast Long-Term Earnings Growth Rate: 8-12% Typical Commission Structure: 50% of first-year premium and a renewable commission of 5-15%, depending on the policys persistency
Product Description
Disability insurance (DI) provides income to individuals suffering from a recent disability that precludes them from working. Most disability insurance is provided through employer-paid and government-sponsored programs, and a smaller amount is purchased by individuals. A group DI policy typically pays 45-60% of annual income upon the claim. DI policies are more expensive than term and traditional life policies, costing as much as 2% of annual salaries. Two major types of disability insurance are short-and long-term disabilityshort-term disability (STD) offers benefits for a specified period of time, usually 13, 26, or 52 weeks. Long-term disability (LTD) provides benefits up to age 65 or normal retirement age. Policies can be sold on a noncancelable basis (where policies cannot be repriced or canceled, which can lead to problems if policies were not priced correctly at time of sale) or guaranteed renewable basis (where prices can be adjusted based on loss experience). The largest segment of the disability insurance market has been in the group segment, which comprises employers and groups with more than 100 employees or members. Within the smaller individual disability market, consumers tend to be between ages 35 and 50. These consumers tend to have several dependents and financial obligations or are not covered fully under their group policies.
are harder to forecast, making it more difficult to price the product and creating greater differentials in incidence and loss experience among market participants. The level of interest rates also impacts profitability, as the discount rate applied to reserves must be adjusted over time. Reductions in the discount rate force the insurer to increase reserves, hurting profitability. Scale is another factor impacting profitability, as companies writing a greater volume of business can lower their unit costs and achieve greater profitability.
Salaried employees specializing in group policies are the main channel selling employers group policies. Worksite marketing is another method of distribution for disability insurance. Voluntary employee payroll insurance deductions have traditionally accounted for the majority of disability insurance purchases. Individual disability is sold primarily through independent agents.
2001 448.7 176.9 152.9 113.2 107.5 81.3 53.7 60.6 27.9 87.7 1,310.4 1,740.0
2002 416.3 191.9 179.0 117.2 111.7 103.6 84.2 76.0 63.0 53.9 1,396.8 1,730.0
% Change -7.2% 8.5% 17.1% 3.5% 3.9% 27.4% 56.8% 25.4% 125.8% -38.5% 6.6% -0.6%
2001 Mkt. Sh. 25.79% 10.17% 8.79% 6.51% 6.18% 4.67% 3.09% 3.48% 1.60% 5.04% 75.31% 100.00%
2002 Mkt. Sh. 24.06% 11.09% 10.35% 6.77% 6.46% 5.99% 4.87% 4.39% 3.64% 3.12% 80.74% 100.00%
The market for individual disability insurance is even more concentrated than the group market. The top 10 individual disability companies control 91% of the market,
53
compared with 81% for group disability. UNM is also the leading provider of individual disability insurance, although the company is also losing share in this market (26.6% in 2002 vs. 30% in 2001).
Table 16: Total Individual Disability Market
$ in millions, as ranked by 2002 total individual disability sales premiums 2001 Rank 1 2 3 7 5 6 4 10 8 11 2002 Rank 1 2 3 4 5 6 7 8 9 10 Company UnumProvident Mass Mutual Northwestern Mutual Life Berkshire Life MetLife Principal Financial IDS Life Standard State Farm Union Central Top 10 Companies Total 2001 78.1 35.4 34.9 10.0 18.6 16.9 18.7 5.9 9.3 5.8 233.6 259.9 2002 78.9 38.2 33.9 31.1 22.9 19.5 18.9 11.0 7.7 7.4 269.6 296.2 % Change 1.1% 7.8% -2.8% 210.2% 23.2% 15.0% 1.4% 85.2% -16.4% 28.3% 15.4% 14.0% 2001 Mkt. Sh. 30.03% 13.62% 13.43% 3.86% 7.15% 6.52% 7.19% 2.28% 3.56% 2.22% 89.87% 100.00% 2002 Mkt. Sh. 26.64% 12.88% 11.46% 10.51% 7.73% 6.57% 6.39% 3.70% 2.61% 2.50% 91.00% 100.00% bp Change (339) (74) (198) 665 58 6 (79) 142 (95) 28 113 0
Source: John Hewitt and Associates and JPMorgan calculations. Note: Bolded companies are those under JPMorgan life insurance coverage
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and how it fits into their financial plan should be an important driver of sales in the future. Increased sales of voluntary benefits through the worksite, also a relatively underpenetrated market, should help drive sales growth. As the size of the market increases, companies should also begin to benefit from scale.
55
Key Statistics:
Return on Equity: 12-14% Forecast Long-Term Earnings Growth Rate: 11-12% Typical Commission Structure: 50-66% first-year premiums and an average commission of 13% of premiums on renewals.
Product Description
Long-term care insurance (LTC) protects the insured against all or a portion of the expenses incurred from services needed to assist the protected in carrying out daily living activities (such as bathing, dressing, eating, etc.) when they are unable to perform these activities by themselves. LTC provides coverage for chronic physical and mental conditions, which traditional health insurance does not typically cover. Long-term care policies extend to patients with cognitive impairments (such as Alzheimers disease) as well. Nearly 92% of the long-term care market is individual long-term care, while the remaining 8% is group long-term care. Most purchasers of long-term care are over 65, although the market for LTC insurance for those under 65 is growing more rapidly and represents an opportunity for insurers.
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Source: A.M. Best and JPMorgan calculations. Note: Bolded companies are those under JPMorgan life insurance coverage.
The Federal Long Term Care Insurance Program, should help drive LTC growth. The program, a joint venture of MetLife and John Hancock, should raise consumer awareness of the benefits of long-term care and help familiarize consumers with the product. Group LTC should become increasingly important. Currently, 92% of the long-term care market is for individual long-term care. Over time, the demand for group long-term care is expected to increase as companies develop group long-term care and disability and group life products. Regulatory developments are also likely to have an impact on LTC growth going forward. The continued development of long-term care will also depend on continued federal funding of programs such as Medicare, which pay for a portion of the expenses that are associated with long-term care. Proposed legislation allowing tax deductions for individual LTC premiums could also increase the market potential for LTC. The rising cost of LTC is one factor that may limit growth for the market. LTC is an expensive product and difficult for many middle class consumers to afford, which may limit its growth potential. The costs of longterm care are rising rapidly as a result increasing demand for limited numbers of service providers, as well as the costs associated with providing service to the elderly. Long-term care costs have been outpacing inflation by about 3% a year.
58
Key Statistics:
Return on Equity: 12-13% (varies by product) Forecast Long-Term Earnings Growth Rate: 10-12% Typical Commission Structure: Cancer/Accident: 35-60% of first-year premiums, 3-5% renewals Medicare supplement: 20-23% of premiums (first year and renewals)
Product Description
Supplemental health insurance typically supplements coverage provided by primary health insurance, reimbursing expenses not covered by major medical. Policies are sold on both a group and an individual basis. Types of supplemental health coverage include cancer, Medicare supplement, hospital indemnity, accident, and dental insurance. Purchasers of supplemental health products vary by coverage: Cancer and accident policies are aimed at consumers with major medical coverage seeking additional coverage. Hospital indemnity products are typically aimed at lower-income or selfemployed individuals lacking major medical coverage. Medicare supplement policies are targeted at Medicare beneficiaries (usually senior citizens), about 85% of whom purchase some form of Medicare supplement insurance.
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Scale and efficiencies are also important drivers of profitability in the supplemental health market. Greater scale allows companies to lower their unit costs, increasing profitability for the product. It also gives companies greater flexibility to pay greater commissions, which in turn can help drive sales growth.
Product Outlook
Growth in the supplemental health market, which continues to be underpenetrated, should generally remain strong, while growth in the Medicare Supplement market is likely to be more modest. Sales of supplemental health products are likely to remain strong as companies focus on penetrating the market. AIG recently signaled it would begin offering supplemental medical products, which could make the market incrementally more competitive. However, given the low penetration of supplemental health products, competition is likely to remain subdued as companies focus on educating consumers about the need for these products. Heavy regulation and unaffordable, high policy premiums are likely to continue to hold back growth in the Medicare supplement market. Allowing higher deductibles would allow providers of Med-Supp policies to decrease premiums, which would increase the affordability and persistency of the policies. It is unlikely, however, that significant modifications to the current array of standardized plans will be achieved before 2004.
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There are several key differences between GAAP and statutory capital. GAAP capital for insurance companies generally reflects economic capital, or the difference between assets and liabilities on the balance sheet. Statutory capital differs from GAAP capital in that some GAAP assets are not admitted as statutory capital. Certain assets, including certain receivables and furniture and equipment net of depreciation, that are included in GAAP assets are not admitted under SAP. SAP also places restrictions on the recognition of deferred tax assets. Risk-based capital (RBC) ratios are a key metric used in evaluating the adequacy of a companys statutory capital. The National Association of Insurance Commissioners (NAIC) has established the most widely used risk-based capital formula. Capital requirements are determined for each insurer based on the risk profile of the companys business mix and investment portfolio. Statutory capital is then divided by required capital to product the RBC ratio, expressed as a percentage. Life insurers generally target an RBC ratio of roughly 300% to maintain an AA rating. As of the end of the third quarter of 2003, most companies in the sector met or exceeded their targeted range. Companies in the sector typically have financial strength ratings from the two major ratings agencies, Moodys and Standard & Poors, in the Aa /AA range.
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Source: Company reports and JPMorgan calculations. Moodys and Standard & Poors ratings refer to insurer financial strength ratings. *AFL, TMK excess capital reflects only approximate annual free cash flow generation. **Updated RBC ratio for JHF as of 3/31/03. Updated RBC for JP, LNC, MET, MFC, NFS, PL, PNX and UNM are as of 9/30/03; MFC RBC reflects MCCSR. **** JP excess capital includes $300 million in marketable securities.
company yields 1.4% and pays out 22.6% of net income as dividends. While this is higher than for the typical broker or asset manager, payouts for life insurers are lower than those paid by banks and thrifts, which are closer to life insurers in terms of earnings growth and returns. Share buybacks tend to be more irregular than dividend payouts, although a few companies have maintained regular share buybacks. A number of companies, for instance, were forced to suspend their buyback programs as a result of capital pressures in 2002. Only a few (AFL, JP, PFG, TMK) maintained their buyback programs through the downturn. The average life company pays out about 22.6% of its earnings in dividends. Payout ratios for some companies are understated if capital returned to shareholders in the form of share buybacks is included, although few companies (including AFL and TMK) buy back stock on a regular basis and including these buybacks would probably not significantly raise the average payout ratio for the industry. This payout compares with an average yield of 2.5% for banks, 2.1% for thrifts, and 1.9% for asset managers, and 1.1% for broker/dealers, and payout ratios of 39% for banks, 32.4% for thrifts, 41.2% for asset managers, and 14.7% for broker dealers. Given the maturity and modest growth prospects of the life insurance industry, we think a payout ratio closer to that of the banks (at 40%) would probably be more appropriate and would increase the appeal of life insurers with investors.
Table 19: Companies with Low Payout Ratios May Raise Dividends
Company AFLAC AIG Hartford Financial* Jefferson-Pilot John Hancock Lincoln National Manulife Metlife National Financial Partners Nationwide Phoenix Cos. Principal Financial Protective Life Prudential Reinsurance Group Torchmark Corp. UnumProvident** Average Price 1/12/04 35.39 70.50 62.69 49.38 39.44 41.33 33.83 32.63 30.25 34.43 13.04 32.32 33.97 42.26 38.34 45.45 15.75 Annual Dividend 0.32 0.26 1.12 1.32 0.35 1.34 0.62 0.23 0.40 0.52 0.16 0.45 0.64 0.40 0.24 0.44 0.30 Yield 0.90% 0.37% 1.79% 2.67% 0.89% 3.24% 1.84% 0.70% 1.32% 1.51% 1.23% 1.39% 1.88% 0.95% 0.63% 0.97% 1.90% 1.42% 2.5% 2.1% 1.9% 1.1% LTM LTM Payout Net EPS Dividends Ratio 1.73 0.30 17.3% 2.47 0.24 9.8% 5.29 1.09 20.6% 3.08 1.32 42.9% 2.87 0.35 12.2% 2.70 1.36 50.2% 3.19 0.78 24.5% 2.79 0.23 8.2% NA NA NA 2.56 0.45 17.6% -0.51 0.16 NM 2.40 0.45 18.8% 2.55 0.63 24.7% 0.98 0.50 51.0% 3.01 0.24 8.0% 3.63 0.40 11.0% 1.63 0.37 22.9% 22.64% 39.09% 32.41% 41.20% 14.70%
Payout ratios for asset managers are inflated by a few companies with very high payout ratios due to their corporate structure.
Averages for other financial services companies: Banks Thrifts Asset Managers Broker Dealers
Source: Company reports and JPMorgan calculations. Payout ratio is calculated as the last 12 months dividends paid divided by the last 12 months net income. Industry groups include all companies with market caps over $1 billion in each sector. LTM net EPS, dividend figures for Manulife in Canadian dollars. * HIG LTM net income excludes $1.7 billion asbestos reserve charge in 1Q03. ** UNM LTM net income excludes $295 million reserve charge in 1Q03.
See page 81 for more details on the dividend tax cut and its impact on the insurance industry
A number of life insurers raised their dividends as a result of the change in dividend tax rates. The tax rate on dividends was cut to 15% from the higher ordinary rate (as high as 38.5%), prompting a number of companies to increase their dividend payouts. AIG, Principal, and Prudential introduced the largest dividend increases, raising their dividends by 38.3%, 80%, and 25%, respectively.
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Source: Company reports and JPMorgan calculations. Figures represent annual dividends. *Manulife dividend in Canadian dollars.
Asset/Liability Matching
Insurers generally match their investment exposures to the liability the investment is backing. Portfolios are segregated by product, and the investment portfolios of each product tend to have different characteristics. Short-duration products such as fixed annuities and GICs are generally backed by short-duration bonds (although some GICs are have longer durations), while life insurance products have longer durations and are generally backed by bonds with durations of 10 years or more. In general, insurers have greater latitude in choosing investments to back longer duration products, which do not always need to be duration matched, while short duration products must be strictly matched.
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PRODUCT
INVESTMENT
Medium-term bonds
Long-term bonds
The challenge for insurers is to maximize investment yields while minimizing mismatch relative to liabilities. Insurers can generally gain yield by increasing the duration of their assets, but face interest rate risk or liquidity risk if the portfolio duration is extended far beyond the duration of liabilities. Companies can increase yield without affecting duration by taking on additional credit risk, but then lead themselves exposed to higher realized losses (which can also eat into investment yield).
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Figure 13: Out of Mortgages, into Bonds: Investment Exposures Shift over Time
2001
1990
Bonds 75%
Bonds 62%
Other 2%
Real estate 1%
See page 71 for further details regarding company exposure to BIG securities.
Corporate debt generally makes up over half of life insurers fixed maturity portfolios, with an average of 65% of fixed maturity holdings invested in corporate bonds. The key risk associated with corporate debt is credit risk, which varies with the quality of the holding. Below investment grade (BIG) bonds are the lowest credit quality corporate bonds and are most at risk of default. (Note that an insurers aggregate BIG exposure includes below investment grade ABS, MBS, and foreign government holdings, although straight debt is generally the largest component of BIG exposure). Asset backed (ABS)/mortgage backed securities (MBS) are another important asset class, accounting for about 19% of fixed maturities on average. Mortgage-backed securities are generally the larger exposure. While MBS are favored because they are highly liquid and not usually exposed to credit risk, their cash flows are uncertain due to their negative convexity. ABS exposure includes airline equipment trust certificates (ETCs and EETCs), which have come under pressure recently due to turmoil in the airline industry.
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Source: Company reports and JPMorgan calculations. Data as of 9/30/03. * Data for AFLAC as of 12/31/02.
While fixed maturity investments are the primary asset class for life insurers, some companies emphasize other asset classes to achieve higher yields. Principal, Nationwide, and John Hancock, for instance, have heavy exposure to mortgage loans (27.3%, 20.5%, and 17.0%, respectively), which often feature attractive yields relative to those available on corporate bonds. Most U.S. insurers have a relatively small exposure to equities (less than 1% for most companies), due both to regulatory constraints and to the fact that insurers have not wanted to develop a separate staff to invest in equities. Manulife, a Canadian insurer, has the largest investment exposure to the equities, with 7.7% invested in equities, and also has most exposure to real estate relative to the group at 5%, although the companys pending merger with John Hancock (with only 1.6% invested in equities) is likely to reduce this percentage.
Table 23: Exposure to Selected Asset Classes as Percentage of Invested Assets
$ in millions Company AFLAC AIG Hartford Financial Jefferson-Pilot John Hancock Lincoln National Manulife Metlife Nationwide Phoenix Cos. Principal Financial Protective Life Prudential Reinsurance Group Torchmark Corp. UnumProvident Average Ticker AFL AIG HIG JP JHF LNC MFC MET NFS PNX PFG PL PRU RGA TMK UNM Fixed Income 97.0% 59.5% 93.5% 79.9% 73.8% 83.4% 59.8% 76.7% 72.1% 78.4% 65.7% 75.2% 79.3% 50.0% 93.1% 87.8% 76.6% Equities 0.2% 1.8% 0.9% 2.8% 1.6% 0.6% 7.7% 0.8% 0.3% 2.2% 0.7% 0.3% 1.0% 0.0% 0.7% 0.1% 1.3% Mortgage Loans 0.0% 2.5% 1.1% 13.2% 17.0% 9.8% 13.7% 12.2% 20.5% 2.0% 27.3% 16.2% 0.0% 5.6% 1.4% 1.4% 9.0% Real Estate 0.0% 1.2% 0.0% 0.5% 0.4% 0.6% 5.3% 2.6% 0.3% 0.0% 2.7% 0.1% 0.0% 0.0% 0.2% 0.1% 0.9% Policy Loans 0.0% 1.3% 3.4% 3.4% 2.9% 4.5% 5.7% 4.2% 2.2% 13.3% 1.4% 3.2% 2.5% 10.9% 3.4% 7.9% 4.4%
Source: Company reports and JPMorgan calculations. Note: BIG = below investment grade bonds. Data as of 9/30/03
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See page 61 for a more detailed discussion of capital for life insurers.
Source: Company reports and JPMorgan calculations. Note: *AIG gross pretax losses reflect impairments only, converted to pre-tax figures using 35% tax rate. ** MET after-tax losses converted to net pretax losses using a 35% tax rate.
The improvement in realized losses for life insurers mirrors a general improvement in the credit market. Defaults on high-yield issues, which shot
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substantially higher in late 2001 and remained high throughout 2002, began to improve at the end of 2002 and have declined substantially since then. The rolling last 12month rate of defaults has improved substantially from early 2002, when it reached as high as 9.3%. In fact, the December 2003 last 12-month (LTM) rolling default rate was 2.9%, below the 3.73% the default rate has averaged since 1993.
Figure 14: Credit Defaults: On the Mend
Rolling LTM Domestic Default Rate--High Yield 10.00% 9.00% 8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jul-93 Jul-94 Jul-95 Jul-96 Jul-97 Jul-98 Jul-99 Jul-00 Jul-01 Jul-02 Jul-03 Average=3.73%
Source: JPMorgan.
The level of unrealized investment losses held in an insurers portfolio is often an indicator of future losses. Investments held in the general account portfolio are mostly marked to market, with unrealized gains and losses on investments flowing through other comprehensive income and collecting on the balance sheet as part of accumulated other comprehensive income (AOCI). If an insurer holds a position with an unrealized loss at a certain period, the loss may either be erased by subsequent recovery in the holding or the loss can be realized. Losses can be realized either by selling the security or by writing it down to its current market value. Higher levels of unrealized losses increase the likelihood of realized losses in the future, as positions with unrealized losses often must be sold to meet liquidity needs or to avoid further deterioration or as holdings must be written down as it becomes clear that the loss is other than temporary. Companies have considerable discretion as to when losses are realized, but losses cannot be postponed indefinitely if the security is permanently impaired. AIG had the highest unrealized loss on an absolute dollar basis at $2.4 billion, although AIGs unrealized loss as a percentage of invested assets (0.5%) and shareholders equity (3.6%) are below the life group averages. As a percentage of equity, John Hancock and Manulife had the highest levels of unrealized losses at 6.0% and 18.7% of equity, respectively. Manulifes unrealized loss reflects primarily unrealized losses on equity investments held in the surplus account.
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Source: Company reports and JPMorgan calculations. Unrealized loss figures for AFL, MFC reflect unrealized loss on entire portfolio; other companies reflect unrealized loss on fixed maturity portfolio only. Note: * Figures for Manulife translated from Canadian dollars.
The largest holders of MBS include Protective Life (25.8% of assets), Hartford (18.7% of assets), and MetLife (18.9% of assets). Of these companies, Protective has the largest exposure to residential pass-through securities (generally the most exposed to variation in prepayment rates) at 10%, versus 4.1% for HIG and 7.1% for MET.
Table 26: Exposures to Selected Asset Classes, Percentage of Assets
$ in millions Company AFLAC AIG Hartford Financial Jefferson-Pilot John Hancock Lincoln National Manulife* Metlife Nationwide Phoenix Principal Financial Protective Life Prudential** Reinsurance Group Torchmark Corp. UnumProvident Average Invested Assets 42,711.0 491,095.7 75,503.0 25,343.0 73,562.6 42,423.0 54,977.8 210,951.0 42,886.4 16,600.8 56,325.9 16,718.0 118,343.0 7,791.7 8,561.0 34,618.9 BIG BIG % of MBS MBS % of Bonds Investments Exposure Investments 1,284.5 3.0% 0.0 0.0% 36,046.0 7.3% NA NA 3,573.0 4.7% 14,142.0 18.7% 1,456.0 5.7% 3,641.0 14.4% 5,830.0 7.9% 9,141.5 12.4% 2,441.5 5.8% 4,992.7 11.8% 1,342.6 2.4% 410.2 0.7% 12,184.0 5.8% 39,794.0 18.9% 1,863.6 4.3% 4,860.0 11.3% 1,119.6 6.7% 3,731.0 22.5% 3,043.5 5.4% 5,565.7 9.9% 1,021.9 6.1% 4,307.2 25.8% 6,227.0 5.3% 5,021.0 4.2% 24.6 0.3% 818.0 10.5% 768.0 9.0% 162.0 1.9% 2,473.4 7.1% 4,778.0 13.8% 5.4% 11.8%
Source: Company reports and JPMorgan calculations. *Manulife figures converted from Canadian dollars. **Prudential figures reflect financial services business only.
yields seen in early 2000. Increasing rates in 2004 (as many market participants expect) would relieve downward pressure on investment income and portfolio yields.
Table 27: Low New Money Yields Continue to Pressure Portfolio Yields
Company AFLAC AIG Hartford Financial Jefferson Pilot John Hancock Lincoln National Manulife Financial MetLife Nationwide Financial National Financial Partners Phoenix Cos. Principal Financial Protective Life Prudential Financial RGA Torchmark UnumProvident Average Yield 9/30/03: Portfolio New Money Difference 7.63% 6.29% 1.34% NA NA NA 5.60% NA NA 6.44% 4.68% 1.76% 5.54% NA NA 6.43% 4.75% 1.68% 6.36% NA NA 6.66% 4.20% 2.46% 5.85% 5%- 5.25% 0.60% - 0.85% NM NM NM 6.00% NA NA 6.30% NA NA 6.66% 5.50% 1.16% 6.22% 4.40% 1.82% 6.66% 5.88% 0.78% 7.00% 6.30% 0.70% 7.26% 5.75% - 6.00% 1.26% - 1.51% 6.44% 5.30% Portfolio Yield 06/30/2003 7.33% NA 5.80% 6.59% 5.76% 6.49% 6.84% 6.76% 5.93% NM 6.10% 6.50% 6.71% 6.35% 6.67% 7.37% 7.40% 6.57% Change in yield (BP) 30.0 NA -20.0 -15.0 -22.0 -6.0 -48.0 -10.0 -8.0 NM -10.0 -20.0 -5.0 -13.0 -1.0 -37.0 -14.0 Duration 9/30/03 8.7 NA 4.8 4.8 4.0 5.2 NA 5.2 4.5 NM NA NA 5.0 5.0 6.5 6.4 8.8 5.7
Source: Company reports and JPMorgan calculations. Note: Portfolio durations for HIG, NFS as of 12/31/02. Portfolio yields for AFL, PRU reflect U.S. business only. Portfolio durations for AFL, PRU, RGA reflect U.S. portfolios.
Industry Consolidation
See our detailed report titled Life Insurance Consolidation: We Favor the Buyers published December 3, 2003, for more details on consolidation.
Renewed consolidation in the life insurance industry should benefit well positioned, scale players in key businesses, which are likely to be buyers. We believe consolidation in the industry is inevitable and likely to accelerate in 2004 as operating trends improve, capital flexibility increases, and ratings agency pressures lift. We expect greater capital flexibility in 2004, driven by credit market improvements, which should drive lower levels of realized investment losses, and recent equity market strength, which should result in continued improvements in VA earnings and reduced death benefit expenses. Right now, capital and valuation constraints imply that there are few eligible buyers, while we expect the forces driving consolidation to gradually pressure companies to sell non-core businesses, sell their company, or participate in a merger of equals. We prefer potential buyers, since they are likely to gain scale and efficiency through consolidation, driving stronger earnings growth and returns. The competitive environment in the life insurance industry remains crowded, which should continue to drive consolidation activity. The life insurance industry continues to suffer from overcapacity, with a large number of players selling commodity-like products through cluttered distribution channels in a highly regulated market, with modest top-line growth and an increasing need for scale and efficiency. These pressures have sparked recent life insurance deal activity, with Hartford buying CNAs group life and disability businesses, MetLife buying TIAA-CREFs long-term care business, Prudential buying Cignas retirement business, Manulife buying John Hancock, AXA buying MONY Group, RGA buying Allianzs life reinsurance business, Safeco announcing it is selling its life insurance business, and GE announcing it would spin off its life business.
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Source: See table. *Total companies indicates only total of companies (with consolidated subsidiaries) captured by data source, which likely understates the total in some cases. ** Data represents latest data available.
sale. However, given its size, we think the company needs to gain more scale to compete with larger players or be sold if it is not a core focus for Citigroup. We believe the company is more likely to be a seller or spin the business off in an IPO (like GE), given its increasing focus on its core banking operations. Citi has already spun off its property casualty operations (Travelers). Unless Citi decided to break up the business, only a large, diversified financial services company would be likely be able to buy the whole business, which we think could be worth about $8 billion. With its mix of fixed and variable annuities and individual life insurance, there could be several interested parties if the business is split into pieces. European companies are likely to take a relatively cautious approach to deals in the U.S. than in the past. European companies were active acquirers of U.S. life insurance assets in the 1990s: ING made two large purchases, Equitable of Iowa in 1997 and ReliaStar in 2000; and AEGON purchased Transamerica in 1999. These purchases were made at valuations well above current industry valuations because of their significant valuation premium over U.S. companies. Today, foreign companies have limited (if any) premium over U.S. companies and that, combined with flowback issues and limited free capital, would likely prevent them from being size buyers in the near term. More recently, AXA announced the acquisition of the MONY Group, although the size ($1.5 billion) and valuation (a 27% discount to BV) for this deal were more modest than for deals executed in the 1990s. AXAs deal is likely more representative of the types of deals European insurers would now pursue. Companies that we believe could emerge as sellers include Jefferson Pilot, Lincoln National, and Phoenix. These are companies we believe have businesses that could be attractive to an acquirer and that would be more attractive in the long term if they had greater scale. More generally, we think nearly every company in the life insurance sector could emerge as a buyer or seller, capital and valuation permitting.
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Valuations of recent deals appear modest relative to the recent past, however. In the late 1990s, life and health insurance deals saw average valuations of close to two times book value and P/Es above 20. While these valuations were likely inflated due to the robust performance of the equity market, valuations of recent deals have been much more constrained. While consolidation activity should generally support valuations in the sector, given industry dynamics and current trends we do not believe sellers are likely to receive the rich premiums they saw in the late 1990s. Hartford purchased group life and disability businesses from CNA at a 30% discount to book value. PRU acquired Cignas retirement business for a relatively modest valuation of 8.5 times 2004E earnings. Manulifes bid for John Hancock offered only a 30% premium to book value. At 12.1 times and 11.2 times our 2003 and 2004 estimates, respectively, Manulifes bid for JHF also does not appear to be aggressive. While P/E ratios are inflated due to the MONY Groups depressed earnings, AXAs bid for MONY values the stock at a 30% discount to book value.
Table 30: Average Multiples of Life, Health Announced Deals
1997 Valuation: Median Price/ Earnings (x) Average Price/ Book (%)
Source: SNL.
17.57 1.98
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Figure 15: Deal Activity Picking Up in 2003, but Still Off Peak
40,000.0 35,000.0 30,000.0 25,000.0 20,000.0 15,000.0 10,000.0 5,000.0 0.0 1997 1998 1999 2000 2001 2002 2003 YTD 2,718.0 10 0 11,320.4 16,198.7 12,393.2 13,050.0 29,018.4 33,915.3 60 50 40 30 20
Source: SNL. Note: 2001 excludes Prudential Plcs $24.6 billion unsuccessful bid for American General, which was subsequently purchased by AIG.
The largest acquirers of life insurance companies in the 1990s included diversified financial services companies (particularly AIG) and major European insurers. AIG executed two of the largest life insurance acquisitions of the past five years, acquiring SunAmerica in August 1998 for $19.7 billion in stock, and later buying American General in 2001 for $23 billion in stock. Both acquisitions expanded AIGs presence in various life insurance businesses and made the company a leading provider of variable annuities. European insurers were active acquirers of U.S. life insurance assets in the 1990s. ING made two large purchases, buying Equitable of Iowa in 1997 for $2.2 billion and Reliastar in 2000 for $4.9 billion. AEGON made the largest life insurance purchase for a European insurer, buying Transamerica in 1999 for $10.9 billion. In 2000, France-based AXA purchased the 40% of its U.S.-based subsidiary, AXA Financial, it did not already own for $9.5 billion. AXA Financial is the holding company for Equitable Life and AXA Advisors, among other companies.
Table 31: Selected Large Transactions in the Life Insurance Sector
$ in millions Date 12/20/02 12/18/02 8/8/01 7/30/01 5/3/01 4/3/01 1/25/01 8/30/00 5/1/00 9/20/99 2/18/99 11/23/98 8/20/98 9/12/97 7/28/97 7/8/97 2/13/97 Acquiree Name American Skandia Conseco--Assets And Operations Provident Mutual Life Insurance Lincoln National--Reinsurance business Liberty Financial--Keyport Life American General Corp. Fortis Financial Group AXA Financial Reliastar Financial Corp Guarantee Life Companies Inc Transamerica Provident Companies Inc SunAmerica Western National Corp CIGNA--Individual Life, Annuity Business Equitable Of Iowa Companies USlife Corp Average Median
Source: SNL and JPMorgan estimates. 76
Acquirer Name Prudential CFN Investment Holdings Llc Nationwide Financial Serv- A Swiss Re Sun Life Financial Inc American International Group Hartford Financial Svcs Grp AXA Group ING Group NV-CVA Jefferson-Pilot Corp AEGON UnumProvident Corp American International Group American General Corp Lincoln National Corp ING Group NV-CVA American General Corp
Deal Value $1,265.0 850.0 1,120.0 2,000.0 1,700.0 22,989.1 1,120.0 9,503.6 4,969.1 415.3 10,938.1 4,550.3 19,676.9 1,163.0 1,400.0 2,179.9 2,177.8
Payment Type Cash Cash Cash and Stock Cash Cash Stock Cash Cash and Stock Cash Cash, Stock & Debt Cash, Stock & Debt Stock Stock Cash and Stock Undisclosed Cash and Stock Stock
P/BV 0.7 NA 1.3 2.9 1.3 2.7 NA 1.5 2.4 1.4 1.7 1.3 5.7 2.1 NA 2.6 1.5 2.0 1.5
P/E-- Last FY NA NA 14.9 16.0 17.1 22.3 NA 12.3 18.2 20.7 14.3 15.0 34.3 18.0 NA 17.6 22.1 18.2 17.3
P/E Forward (est.) 8.0 NA 13.4 14.8 NA 16.0 NA NA 15.6 17.0 19.4 NA 33.0 16.9 NA NA 14.1 15.6 15.2
A.M. Best and JPMorgan calculations. All figures represent statutory figures and reflect aggregates for life insurance subsidiaries only. Mutual companies are bolded.
Mutual insurers are oriented to maximize solvency, not returns, which allows them to be more aggressive in some markets than stock companies. The lack of pressure from public shareholders to generate high ROEs often allows mutual insurers to price their products more competitively than stock companies. This can reduce returns in markets where mutual companies have chosen to compete aggressively. Since they do not have a stock currency, it is more difficult for mutual companies to execute acquisitions. The lack of a stock currency makes it very difficult for mutual insurers to participate in industry consolidation, which is one reason many mutual companies have chosen to come public.
have formed holding companies to more effectively compete with pure stock companies. Still, it is likely that other mutuals will convert to stock companies in the coming years. A large number of mutual insurers chose to convert to stock companies in the late 1990s and early 2000s. Companies that have demutualized include smaller companies such as the MONY Group and Stancorp and some of the largest companies in the industry, such as MetLife and Prudential Financial. The largest Canadian life insurers, including Sunlife, Manulife, and Canada Life, also underwent demutualization in the late 1990s. Most deals were priced at book value or below, although a few companies that came public before the equity market decline in 2001 sold stock at a premium to book value.
Table 32: Recent Demutualizations in United States, Canada
Company Mony Group StanCorp. Financial Group Clarica Life Manulife Canada Life John Hancock Sun Life of Canada Metlife Phoenix Life Insurance Principal Financial Prudential Financial Average
Source: Company reports and JPMorgan calculations.
Date of Demutualization 11/16/1998 04/16/1999 07/15/1999 09/24/1999 10/28/1999 01/27/2000 03/23/2000 04/05/2000 06/20/2001 10/23/2001 12/13/2001
IPO Price 23.50 23.75 C$20.50 C$18.00 C$17.50 17.00 C$12.50 14.25 17.50 18.50 27.50
BV Multiple 0.65 0.92 1.17 1.45 1.00 1.00 0.85 0.77 0.79 1.01 0.85 1.01
the equity of a mutual company is owned by the cooperative. Individuals have no right to the equity a mutual except in the case of dissolution. During a demutualization, equity payments are made to policyholders through cash or stock offering. The firm recapitalizes once all of the equity has been repaid, most often through an IPO. This process usually lasts a year and a half to two years. Conversion is another method that allows a mutual company to become public through selling policyholders shares of stock equal to the valuation price of the initial offering price of the stock. The stock is then listed on an exchange and becomes publicly traded. While conversion is common, most mutual companies choose to demutualize. Sponsored demutualization is another way mutual companies can become public. In a sponsored demutualization, the mutual company exchanges its equity for shares in a publicly traded life insurer instead of launching an IPO on its own, and merges with the publicly traded company. Two examples of sponsored demtualizations include Provident Mutual (purchased by Nationwide Financial) and Indianapolis Life (purchased by AmerUs). A mutual holding company structure maintains the company's ownership by policyholders, but enables it to issue stock for sale to the public. Insurers reorganize into a stock life insurer by forming a new mutual holding company. This new holding company owns, directly or through one or more stock holding companies, the mutual life insurer. The mutual holding company is able to sell stock and have access to the capital-raising marketplace and pursue affiliations with companies. The Nationwide group has more than $117 billion in assets. Nationwide Mutual Insurance is the parent company of Nationwide Financial Services with Nationwide Financial as the holding company for Nationwide's retirement savings operations and Nationwide Life Insurance Co. Other examples of mutual holding structures include Principal Financial, Pacific Life, and Minnesota Life.
Regulatory Issues
Regulatory scrutiny due to the mutual fund scandal, a push to create new savings accounts, and tax cuts are among the regulatory issues affecting insurers. Insurance is a highly regulated industry, and life insurers operate within a complex regulatory framework. The industry has recently come under scrutiny from regulators due to the recent mutual fund scandal, although we think the ultimate exposure for insurers will be limited. In addition, the Bush administrations push to create new taxadvantaged savings plans could create additional competition for variable annuities and could reduce their appeal. Also, since tax advantages are the primary appeal of many insurance products, the industry is sensitive to changes in tax rates and recent changes in the dividend and capital gains tax rates have had ramifications for many life insurance products, and have also led some life insurance companies to reevaluate their dividend policy.
event that market timing or late trading occurred in the mutual fund underlying the variable annuity. Variable annuities could also come under fire for their fee levels. Market timing takes advantage of the fact that net asset values for funds (particularly international funds) sometimes lag market developments. Market timing is possible in variable annuities, but it is really being done in the mutual funds embedded in the variable annuity product and the responsibility would appear to be with the asset manager or the broker. Given that the large component of variable annuity assets is in mutual funds, the opportunity for market timing and late trading exists. Customers are allowed to switch among mutual funds without triggering a tax event. Also, the mutual funds embedded in the variable annuities are the same funds consumers can buy in the retail market. Companies with broker/dealer or asset manager subsidiaries are most likely to be exposed to this issue. While we do not think variable annuity companies are likely to bear responsibility for mutual fund timing, nearly every asset manager in the United States has received a request for information regarding market timing. MetLife, Phoenix, Lincoln, AIG, Principal Financial, John Hancock, and Prudential all own asset managers. Among life insurers, Prudential has received the most scrutiny as a result of the scandal, but the company is cooperating fully with investigators. While PRU has entered into a joint venture with Wachovia, PRU is exposed to risk if Prudential Securities is found liable for any damages on events occurred prior to the Wachovia deal. The SEC charged five former Pru Securities brokers and one branch manager with conducting market timing trades in mutual funds. The company has also received a subpoena from the U.S. District Attorney in Massachusetts requesting information regarding mutual fund timing. While Prudential has not been charged with any wrongdoing, the company has been incurring litigation expenses, in the form of lawyer and legal fees, to defend itself from any adverse developments. While it is difficult to gauge the companys ultimate exposure to this issue, management appears to be doing everything possible to satisfy the regulators.
competition for retirement savings dollars and reduce the appeal of VA products. The new plan could also introduce a savings plan similar to a 401(k), as was included in the earlier proposal. LSAs would allow individuals to contribute $7,500 after taxes each year, and gains on the account would not be taxed. Funds could be withdrawn at any time. RSAs would also be funded in after-tax dollars and have an annual contribution limit of $7,500, and gains could also be withdrawn tax free, although funds could only be withdrawn after retirement. While individuals would not need earnings to contribute to an LSA, RSAs could only be funded with the account holders earnings. Additionally, RSA funds could not be accessed before age 58. Whereas gains on the LSA and RSA would not be taxed, gains from annuities are sheltered from taxes but withdrawals are taxed at the ordinary income tax rate.
We do not think the proposals spell the end of the variable annuity industry. If the plan is approved as is, the industry may be forced to focus on either building up new products (like long-term care which caters to an older market) or focus more on products in the payout, rather than accumulation phase, like immediate annuities. Companies in the industry could also create wrap products for these savings plan products and/or encourage consumers to put variable annuities in these savings plan products to get a death benefit, principal protection, or guaranteed returns. Additionally, the plans are still likely to face stiff opposition, given growing budget deficits, and the plans are likely to be significantly altered as they make their way through Congress.
The reduction in the dividend tax rate appears to be having little negative impact on the variable annuity industry. Congress approved a tax cut measure that included a reduction in the dividend tax rate to 15% from the current rate (where dividends were taxed as ordinary income, at a rate up to 38.6%). The industry continues to lobby for a similar reduction in taxes on variable annuities. The lobbying arm of the life insurance industry, the American Council of Life Insurers (ACLI), undertook an aggressive lobbying effort to have the dividend tax reduction applied to annuities, but it was unsuccessful. The industry continues to lobby for a reduction in the tax rate on income from variable annuities upon annuitization, and industry officials expect to be successful in winning a reduction sometime in 2004. Given strains on the budget, however, and the size of tax cuts already pushed through by the administration, we think these efforts face an uphill battle. Variable annuities require a long holding period (roughly 12 years) for their tax advantages to overcome higher fees compared to taxable mutual funds. Since withdrawals on variable annuities will continue to be taxed at ordinary tax rates, a reduction in the tax on dividends in mutual funds would erode the tax advantages annuities have over taxable mutual funds and cause the breakeven point, or holding period, to extend to about 15 years. This analysis assumes that variable annuity dividends get taxed at the ordinary rate and that dividends represent about 40% of mutual fund income.
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The tax cut reduces the relative appeal of variable annuities, but does not appear to have significantly impacted sales. The new tax legislation reduces the relative attractiveness of variable annuities over mutual funds because the income on annuities is taxed at ordinary income tax rates when withdrawn. However, we believe that agents and brokers will continue to aggressively market variable annuities because of the products other tax deferral features, death benefits, and high commissions paid to distributors. Strong growth in VA sales in the second quarter of 2003 seems to indicate the impact of the dividend tax cut on VA sales is modest, at most. A number of life insurers raised their dividends as a result of the change in dividend tax rates. The tax rate on dividends was cut to 15% from the higher ordinary rate (as high as 38.5%), prompting a number of companies to increase their dividend payouts. AIG, Principal, and Prudential introduced the largest dividend increases, raising their dividends by 38.3%, 80%, and 25%, respectively.
Table 33: Summary of Companies Increasing Dividends in 2003
Company AFLAC AIG Hartford John Hancock Lincoln National Manulife Metlife Principal Prudential Torchmark Old Dividend $0.28 0.19 1.08 0.32 1.34 0.72 0.21 0.25 0.40 0.36 New Dividend $0.32 0.26 1.12 0.35 1.40 0.84 0.23 0.45 0.50 0.44 Increase 14.3% 38.3% 3.7% 9.4% 4.5% 16.7% 9.5% 80.0% 25.0% 22.2% Dividend Yield 0.9% 0.4% 1.8% 0.9% 3.4% 2.0% 0.7% 1.4% 1.2% 1.0%
Source: Company reports and JPMorgan estimates. Figures represent annual dividends. *Manulife dividend in Canadian dollars.
Background on the Tax Bill On May 22, 2003, republicans in the House and Senate reached agreement on H.R. 2, the Jobs and Growth Tax Relief Reconciliation Act of 2003. The proposed bill encompasses $350 billion in tax cuts, including an aid package for states worth $20 billion. While substantial, the tax cut package is lower than the amount the White House initially envisioned. Among the various features of the bill is a proposal to reduce the capital gains tax rate from 20% to 15% (and from 10% to 5% for lower bracket taxpayers). In addition, the bill proposes a reduction in the tax rate on corporate dividends from the ordinary tax rate, which can be as high as 38.6% currently, to the new rate for capital gains taxes. Thus taxpayers in the top income bracket will pay a 15% tax rate on corporate dividends while those in the lowest bracket will pay 5%. Additionally, in 2008, the dividend tax rate for those in the lowest income bracket will go to 0%. However, the dividend tax reduction expires in 2009 due to a sunset provision. In 2009 and beyond, dividends will be taxed at the ordinary income tax rate for individuals in all tax brackets, as they are currently. It is highly likely that republicans will mount an effort to make the tax cut permanent in the future, however.
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Premiums are non-investment revenues earned from traditional insurance products such as term life and many health insurance products. These are often known as FAS 60 products. Insurers sometimes disclose gross premiums, reinsurance ceded, and net premiums, with net premiums being most relevant to earnings (although gross premiums can indicate top-line growth potential). Premiums can be modeled as a percentage of average insurance in force. Fees are driven by the level of life insurance in force and the level of separate account assets. These are generally earned on variable annuities and variable and universal life (often known as FAS 97 products). Insurers provide different levels of detail regarding these fees and the line items are called by various names, including expense assessments, (LNC) variable annuity and life fees, (JHF and HIG) and asset fees. Fees for these products, particularly for variable annuities, can be projected by multiplying a fee rate by the average account balance associated with the product. Net investment income, which represents investment income earned on reserves associated with products (such as traditional life, fixed annuities, health insurance products, and universal life) held in the general account. Some insurers disclose several components of net investment income, but the final (net) figure is generally the most relevant. Net investment income can be projected multiplying the average general account balance associated with a given product by a reasonable yield. Projecting investment income in this way is most useful for products such as fixed annuities and GICs, for which companies typically disclose detailed account value information.
The level of detail regarding expenses disclosed by insurers also varies, although expenses generally fall into these categories: Benefits are generally the largest expense items associated with insurance products. These consist of death benefits and disability payments associated with a given product. Benefits can be projected as a percentage of premiums, which varies with the type of product and the underwriting skill of the
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company. Benefits for companies not as skilled at underwriting will generally tend to be both more volatile and higher as a percentage of premiums. Interest credited represents interest payments made to holders of fixed-return type products such as fixed annuities, universal life, and GICs. It is usually broken out as a separate expense line, although it is sometimes consolidated in the benefits line. Interest credited can be projected as a percentage of the general account balance associated with the business segment being modeled. Commissions, DAC, and DAC amortization are three interrelated expense items. Commissions are mostly commission payments made to agents and other salespeople for selling a product. DAC is a contra-expense consisting of commission expenses that are capitalized. These commissions later flow through the income statement through the DAC amortization line. Commissions can be projected as a percentage of deposits or new sales. DAC and DAC amortization are difficult to model, but generally are related to sales and the size of the asset base associated with a product. They also depend on the performance of assumptions underlying the product, including persistency and profitability. Operating expenses represent overhead and general operating expenses associated with the business. They can be projected as a percentage of premiums or revenues, which should be a relatively stable relationship, although companies with opportunities for expense savings should see a decline in this ratio over time. Companies achieving greater scale in a given business should also see this ratio decline.
Table 34: Summary: Important Income Statement Line Items and Major Drivers
Line item Revenues: Premiums Driver Insurance in force Description Premium income from traditional life products, recognized proportionally over the life of the policy. Fees Reserve balances/ Fees charged on average account balances associated with Insurance in force variable annuities. Also, cost of insurance fees charged based on the face value of variable life and universal life policies Net investment income Reserves / invested assets Investment income earned on all products backed by general account (fixed annuities, GICs, health insurance products) Premiums Reserves/invested assets Sales Deposits Various Premiums / revenues Death benefits associated with life insurance products, disability income payments, and other benefit payments. Interest payments associated with general account products. Payments (to agents and other producers) associated with sales of products. Commissions, selling expenses capitalized at time of sale Capitalized selling expenses amortized over projected life of policy based on basic profitability assumptions. General operating expenses that usually track overall size of business and overhead
Expenses: Benefits / losses Interest credited Commissions DAC DAC amortization Operating costs
Source: JPMorgan.
Growth in deposits and net cash flows are the best indications of a companys success in selling a product. Additions to the account include deposits and investment performance (when investments appreciate). While investment performance is often larger in magnitude than deposits to the account, deposits are one variable that the company can control (through marketing and distribution efforts). Withdrawals, often an indication of how happy policyholders are with their contract, are another important variable in the growth of the account balance. The net of deposits less withdrawals, also known as cash or net flows to the account, indicate how successful the companys efforts to grow the account are. Over time, superior growth in account balances is likely to lead to faster earnings growth for the business.
Table 35: Anatomy of an Account Rollforward
Item Beginning Balance Deposits Surrenders Exchanges Other Ending Balance
Source: JPMorgan.
Description = Previous ending balance New sales and deposits into existing contracts Also called withdrawals Movement to another account, often transfers between fixed and variable accounts. A positive value represents a transfer into the account from another account and vice versa Death benefits, annuitizations, other reductions in the account balance Sum of all of the above
Statutory Accounting
Regulators and ratings agencies use more conservative statutory accounting principals (SAP), not GAAP, to evaluate life insurers. Publicly held insurers generally prepare financial statements using both statutory accounting principals (SAP) and generally accepted accounting principals (GAAP). SAP statements are used in filings with state regulators, while GAAP financials are presented to shareholders. A primary concern of state regulators is to ensure insurers will be able to meet their policy obligations, so SAP financials tend to be focused on solvency (rather than profitability). As a result, capital and net income tend to be lower under SAP than under GAAP. Statutory net income and capital disclosed in SEC filings refer only to individual regulated insurance entities, and often do not compare to consolidated results. Earnings and capital relating to subsidiaries not included in the regulated entity, for instance, are not included in statutory earnings but do appear in consolidated results. International operations, for instance, are often not held by the statutory entity, so earnings from these operations do not appear in SAP net income.
statutory earnings is felt more acutely in times of financial distress and becomes more of a focal point for investors. Commissions and selling expenses are major expenses associated with the insurance business. Under GAAP accounting, policy acquisition costs (DAC) can be capitalized and held on the balance sheet and gradually amortized over the life of the policy, so that the costs of acquiring the policy are matched to the revenue flow of the policy. Acquisition costs are expensed as incurred under SAP accounting. Companies that are experiencing strong sales are likely to show significantly lower SAP than GAAP earnings since SAP accounting demands the up front expensing of acquisition costs, while revenues from the policies accrue to the company over a number of years. In contrast to GAAP, wholly owned subsidiaries are not consolidated but are recorded at statutory equity value. Net income or loss of the subsidiary is not reflected in income but in surplus. Some realized gains recognized under GAAP net income are deferred under SAP net income. Under SAP, realized capital gains on bonds that have appreciated due to changes in interest rates are kept in an interest maintenance reserve (IMR) and amortized over the expected future life of the security. As a result, these gains do not immediately benefit net income. In periods of heavy credit losses, this treatment makes it more difficult for companies to offset realized losses with gains, since interest rate gains are amortized over time.
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2000
Ordinary Life 2001 %Chg. -7.6% 4.3% 9.31% 8.34%% 6.55%ss 6.31% 4.45%% 2000 50% 25% 11% 1% 7% 1% 7%
2000
Group Life 2001 %Chg. 4.3% 12.9% 22.14% 11.53% 6.49% 6.26% 4.83% 1999 2% 13% 0% 0% 3% 1% 80% 2000 3% 24% 0% 0% 9% 2% 61% 27,062
102,387.2 94,637.3 564,752 588,984 AIG/Amer. General Northwestern Mutual Prudential of Amer. New York Life ING Group 1998 51% 26% 8% 1% 7% 1% 6%
Premiums Key Players by Distribution data by Distribution data by
Hartford Financial Pacific Life Nationwide MetLife AXA Group 2000 52% 27% 14% 1% 0% 0% 5% 2001 48% 29% 17% 1% 0% 0% 4%
MetLife Prudential CIGNA Group Hartford Financial Mass Mutual 1998 3% 14% 0% 0% 9% 2% 72%
Premiums Key players by Distribution dada by Distribution data by
Distribution (% of total) Career agents PPA/independent Broker/Dealer Financial institutions Third party Worksite Other
Sources:
AM Best AM Best
Individual Variable Annuities 2001 2002 %Chg. 113,001.7 886,043.1 113,875.6 795,816.4 0.8% -10.2% 11.2% 9.2% 7.1% 5.8% 5.7% 2001 36% 24% 27% 11% 2% 2002 35% 26% 26% 11% 2%
VARDS VARDS VARDS VARDS
Individual Fixed Annuities 2001 2002 %Chg. 74,300.0 417,000.0 103,300.0 484,000.0 39.0% 16.1% 10.86% 6.73% 6.06% 4.98% 4.65% 2002 12% 38% 7% 36% 8%
Sales data by Assets by Key players by LIMRA LIMRA LIMRA
2000
Total Annuities 2001 %Chg. -17.6% -10.1% 7.70% 7.00% 6.29% 5.62% 5.10%
303,834.4 250,373.7 868,015.9 780,217.6 AIG/Am. General Hartford ING Aegon Nationwide
TIAA-CREF Hartford Financial AIG/Amer. General Aegon AXA Group 2000 34% 27% 24% 12% 3%
Sales data Assets by Key players by Distribution data by
AM Best AM Best
JHA JHA
Note: Individual variable annuity assets refer to assets in variable annuity separate accounts plus the fixed bucket assets of variable annuities. Individual fixed annuity assets refer to total assets in individual fixed annuities. Total annuity reserves refer to statutory reserves for individual and group variable and fixed annuities and are not comparable to assets data.
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Data as of: Aegon/Transamerica Aetna AFLAC Allianz Life Allmerica Financial Allstate Insurance American Enterprise American Express (IDS) AIG/American General American Skandia Annuity & Life Re AXA Group CIGNA Group Citigroup/Travelers CNA Insurance Conseco Group Fidelity Investments Fortis, Inc. GE Life Great-West Life Guardian Insurance Hartford Financial ING Group/Reliastar Jackson National Jefferson-Pilot John Hancock Lincoln National Thrivent Financial Manulife Financial Massachusetts Mutual Merrill Lynch Life MetLife, Inc. Nationwide Financial New York Life Group Northwestern Mutual Pacific Life Phoenix Principal Financial Protective Life Prudential Financial* Reinsurance Group SAFECO Corp. Security Benefit StanCorp Financial Sun Life of Canada TIAA-CREF Torchmark Corp. UnumProvident
Source: JPMorgan.
2002 2002 9/03 2002 2002 2002 2002 6/03 2001 2002 2002 2002 2002 2002 2000 2000 2000 1999 1999 1999 2 7 23 9 12 1 22 8 15 4 20 15 16 9 3 13 5 14 11 2 6 20 6 11 1 8 3 4 17 7 10 11 7 15 1 9 11 12 14 1 9 16 8 10 18 15 4 3 17 22 2 23 21 11 12 18 3 17 1 15 1 8 13 16 12 8 8 13 15 7 14 22 17 9 6 4 18 12 10 21 1 20 1 14 18 13 6 12 5 14 7 11 14 6 3 7 24 7 17 15 7 10 12 5 10 3 22 24 11 4 1 6 25 25 23 2 20 22
18 16 10 3 NA 4 14 19
16 5 20 2
3 23 10 25 24 4 9 19 19 6 8 12 13 7 2 14 6
8 5 13 17 10 2 20 9 7
7 21 2 1
5 1 15 2 21 20 11 14 4 3 2
14 2 4 11 21 13 20 8 10 16 17
22 2 7 18 11 12 24 6 8 19 10 21 23
20 2 7 22 5 21 13 23 25 8 9 17 12
4 8 3 14 10
15 5 4 9 20 16 3 13
9 7 8
4 13
5 1 13 4 25 11 2 3 3 18 16 6 9 6
2 5 4 6 9
13 12 2
2 19 5
22 2
10 8 15 11 23 6 11 15 7 9 1 5
10
8 2
Note: Data represents latest data available (for assets) or latest full-year data available (for sales/ premiums). *Prudential VA assets include American Skandia
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403 (b) 5 12 8 10 3 4 15 19 6
401 (k)
457
risk income
risk income
spread income
Typical returns
9-11%
3-8%
8-11%
11-14%
8-13%
moderate
low
moderate to high
moderate
moderate
high
company
company
company
both
company
typically, customer
Surrender charges
yes
yes
yes
yes
yes
yes
Typical buyer
all ages
40 and up
40-59
Death protection
significant
significant
45-64 modest - available during accumulation phase and if lifetime annuitization chosen mutual fund in insurance wrapper
Described as
na
na
tax-deferred C.D.
Level of complexity
Low
moderate
moderate significant life insurance protection with variable crediting rate long duration of payment
Best features
significant life choice of fixed or insurance protection, variable payments; but payments made for significant life a limited time insurance protection. payment only if death occurs long payment period and low crediting rate
high tax deferral, satisfies significant estate planning needs, significant life insurance protection.
low
moderate tax deferral, higher returns than fixed annuities, death benefits
complex
high fees
no
no
yes
yes
yes
yes
fixed
fixed
variable
both
varies
conservative
both sophisiticated and not incredibly more educted than sophisiticated, risk fixed annuity buyer; averse; lowest income risk tolerant; mid to of three groups upper middle income
fixed
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0.54% 0.55% 0.50% 0.53% 0.47% 0.53% 0.56% 0.59% 0.30% -2.41% 0.36% 0.01% 1.29% 0.75% 1.46% 1.48% 1.67% 1.55% 1.67% 1.61% 1.65% 1.04% 0.96% 0.02% 1.09% 1.07% 1.50% 1.34% 0.73% 0.43% 0.08% 0.29% 0.56% 0.83% 0.91% 0.47% 0.60% 0.53% 0.57% 0.64% 0.67% 0.74% 0.34% 0.27% 0.25% 0.39% 0.27% 0.49% 0.58% 0.50% 0.52% -2.85% 0.52% 0.37% 0.45% 0.42% 0.46% 0.42% 0.29% 0.51% 0.38% 0.40% 0.46% 0.48% 0.47% -1.13% 0.52% 0.38% 0.42% 0.44% 0.20% 0.06% -1.36% -0.35% -0.36% -0.09% 0.02%
0.60% 0.58% 0.52% 0.73% 0.39% 0.38% -0.24% 0.95% 1.90% 0.00% 0.00% 0.82% 1.01% 0.20% -0.10% 0.69% 0.77% 0.71% 0.39% 0.74% 0.59% 0.58% 0.53% 0.86% 0.26% 0.31% 0.64% 0.63% 0.53% -0.29% 0.42% 0.47% 0.43% 0.41% 0.52% 0.55% 0.48% 0.10% 0.69% 0.09% 0.24% -0.39%
LNC Total Annuity MET Total Annuity MFC Variable Annuity NFS Individual Annuity Institutional Annuity Individual + Institutional PNX Total Annuity
Source: Company reports and JPMorgan estimates. *Note: Margin is defined as pretax annuity earnings divided by average annuity assets.
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10.0% 10.0%
29.0% 12.0%
9.7%
41.0%
100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Source: Company reports and JPMorgan estimates. Note: Earnings breakdown based on 2003 earnings estimates. For AIG, Other includes trading, financial products, consumer finance, and ILFC. For JP, Other refers to the communications business. For Principal, Other refers to the mortgage banking business. HIG's earnings from GICs, funding agreements are based on the sales breakdown of the other investment products segment. MET's earnings from GICs, funding agreements are based on general account assets in the retirement & savings segment. NFS's 403(b), 457, 401(k) earnings comprise income from the institutional annuity business.
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Strong Economy X X X
Careful Underwriting
X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X
X X
X X X X X X X X X X X X X X X X X X X X
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Qualified Variable Annuities Nonqualified Var. Annuities Qualified Fixed Annuities Nonqualified Fixed Annuities Group Fixed Annuities. Group Variable Annuities. Traditional Life Variable Life Total Individual Life Retail Asset Mgmt. Institutional Asset Mgmt. Total Asset Management Group Life Long-Term Care Group disability/dental Individual Disability Reinsurance Supplemental Medical International
Source: JPMorgan.
X X X X
X X
X X
X X
X X
X X
X X
X X
X X
X X
X X X X
X X X X
X X X X
X X X X X
X X X X X X X
X X X X X X X
X X X X X X X
X X X X X X X
X X X X X X X
X X
X X
X X
X X
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AIG 4,700
HIG
JHF 2,335
MFC
NFS 550
PL 0 120,613 120,613
PRU 4,281
UNM
186,600 186,600
21,480 23,815
193 193
50 155
375.0 600.0
8 / 102K
25,606 1,037,598
4 336
5 25 1,200 45,000
200,000 186
57,221 75
127
Annuities
Annuities
Annuities
94
Distribution (Cont'd)
AFL Top 3 inv. dealer sellers of products AIG HIG Edward D. Jones JHF Morgan Stanley JP LNC Merril Lynch AG Edwards MET MFC Merril Lynch UBS NFS PFG PL Edward D. Jones AG Edwards PRU Wachovia Prudential TMK UNM Raymond AG Edwards James Linsco Raymond Private James Ledger Royal Wachovia Alliance Securities
Morgan Credit Stanley Suisse First Boston No. of banks/thrift selling agreements No. of banks/thrifts actively selling No. of third-party marketers Names of third-party relationships 25 564 500 214 93 5 Essex
Prudential
Smith Barney
ProEquities
48
55 20
40
15 10
1 INVEST PFIC
27 less than 25
Wholesalers devoted to the bank channel Products sold through banks/thrifts Var. Annuities Fixed Annuities Life Insurance Products currently sold over the Internet Supplement Auto & home al Insurance insurance CDs Consumer Loans Aggregator sites where products are sold? Annuties Var. Annuities Fixed Annuities
54 Annuities Mutual Funds Life LTC Term Life Annuities Annuities Annuities Fixed Annuities Life Insurance Fixed Annuities Var. Annuities Mutual Funds Fixed Annuities Var. Annuities
Annuities
Insurance
Annuities
401(k)
Term Life
Accident Sickness
21st.com, AnnuityZone ReliaQuote AnnuityZone AnnuityNet.c AnnuityZone WorldInsure. AnnuityZone Impact401k. SelectQuote. AIGdirect.co .com and InsWeb .com om .com com .com com com m
PlanSimply.c om
457
1035 Exchange
Annuitization
An annuity that credits a one-time bonus (ranging from 1-6% of the initial deposit depending on the size of the initial deposit) when the product is purchased. To recoup the cost of the bonus, some companies charge an additional fee while others imbed the cost of the feature in the insurance expense. Most bonus annuity products also have a higher first-year surrender charge and/or a longer surrender period to protect the company from premature withdrawals. Corporate-owned / bank-owned life insurance. Insurance owned by corporations covering the lives of employees, with the corporation as beneficiaries. A tax-advantaged investment, COLI and BOLI are often used to fund post-retirement benefits for employees. No-load variable annuity shares. Instead of a front-end or back end load, higher ongoing fees are charged. A special account usually established by insurers at the time of demutualization to separate participating life insurance and annuity policies and the assets that would be used to pay dividends to these contracts. Costs associated with acquiring new insurance and annuity business, primarily commissions, underwriting, and issue and agency expenses. Under U.S. GAAP, these costs are deferred and amortized over the expected life of the policy.
COLI./BOLI
C-share
Closed Block
96
Discount rate used to convert future expected individual disability claims to present value. The rate must be adjusted periodically based on market interest rateslower discount rates increase the value of the liabilities, so that more reserves must be set aside. This flows through the benefits ratio and hurts earnings in the period in which the rate is lowered. A feature typically associated with variable annuities whereby the consumer is offered a bonus crediting rate (usually 50-100 bps higher than the typical crediting rate) on the fixed portion of a variable annuity in exchange for an agreement by the customer that funds will be moved out of the fixed bucket and into the variable buckets (mutual fund options) by a specified time (usually six months or one year). Equity indexed annuities guarantee a fixed return and an additional return based on the performance of an equity market index (usually the S&P 500 Index). Capital held by an insurance company in excess of capital required by ratings agencies to maintain a given rating. Income earned on products that generate fees (like variable annuities, the asset portion of variable life, and asset management). The insurer could earn fee income on mortality and expense fees and asset management fees where the insurer does not bear the investment riskthe consumer does. The insurer shares the asset management fee on the separate account assets with the asset manager since the asset manager manages the assets but the insurer is responsible for marketing and distributing the product. An annuity contract where the consumer is guaranteed a fixed rate of return (reset annually) and income is tax deferred until annuitized. If the consumer withdraws money before the age of 59, there is a tax penalty. Upon annuitization, the consumer pays tax on the deferred income at its ordinary income tax rate. The fixed bucket of variable annuities refers to an investment choice in a variable annuity contract whereby the insurer guarantees the account holder a specified return (usually 3% annually) on assets committed to the fixed bucket. The insurer bears the investment risk in the fixed bucket while the contract holder gets a guaranteed return. Assets that back life insurance, disability, long-term care, fixed annuity, and supplement medical products where the company bears the investment risk and generates a spread between the yield generated on these assets and crediting rates. An institutional contract that guarantees a rate of return on assets for a fixed period. GICS are sometimes used to fund the fixed-income option in defined contribution plans, such as 401(k) plans. A benefit offered in association with variable annuity contracts, where the insurer guarantees to pay a specific death benefit, which may be greater than the underlying account value.
Fee Income
Fixed Annuity
Guaranteed Investment Contract (GIC) Guaranteed Minimum Death Benefit (GMDB) Guaranteed Minimum Income Benefit (GMIB)
A variable annuity benefit that guarantees the customer a return of 3-6% per year during the annuitization period.
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A variable annuity benefit that guarantees the customer's account value will grow at a minimum return each year or reach a certain value by the end of a specific period. The insurer makes up the difference if the account balance does not reach the guaranteed value at the end of the specified accumulation period. A optional benefit for variable annuities that guarantees return of principal to the contractholder. The policyholder can withdrawal their deposit over a period ranging from 5 to 10 years, and the benefit costs from 35 to 65 basis points. Policy where the insurer has the right to reprice the policy if experience deteriorates. This is a smaller segment of the individual disability market (see: Non-Cancelable Individual Disability).
Guaranteed Minimum Withdrawal Benefit (GMWB) Guaranteed Renewable Individual Disability Immediate Annuity Incidence Rate L-Share Variable Annuities
An annuity contract where payouts begin immediately or within one year. Claims per 1,000 lives for a disability policy L-Share variable annuities generally carry surrender charges for 3-4 years (traditional products have surrender charges for 7 years) and have a trailing commission in addition to a set commission in the first year or first 3 years. Termination of insurance policies at the end of the grace period because of nonpayment of premiums. Tax-free investment accounts proposed by the Bush administration. Individuals can contribute up to $7,500 annually to the account, and earnings and capital gains in the account are not taxed upon withdrawal. There is no income limit (i.e. maximum or minimum income) to contribute to the accounts. Insurance that pays for services (i.e., hospice care or nursing home care) when policyholders cannot perform certain activities of daily living, such as bathing and eating etc., without assistance. Long Term Care policies also pay benefits when the insured requires supervision due to a cognitive impairment such as Alzheimer's disease. Insurance fee embedded in the cost of a variable annuity and variable life policy that pays for part of the costs of selling the product (i.e., commissions) and covers the cost if the contract holder dies and the balance in the account is lower than the initial deposit, since the basic death benefit guarantees the policyholder the greater of the initial deposit or current balance. Policies where the insurer cannot change features or raise prices once the policy is in force. The majority of individual disability policies are this type. (see also: Guranateed Reneweable Individual Disability). A plan whereby contributions are not qualified to be made on a pretax basis because the customer already has access to a tax-deferral program like a 401(k) plan. Life insurance and annuity policies historically sold by mutuals that allowed policyholders to participate in the profits of the policy in the form of a dividend. When the mutuals demutualize, they typically separate these policies into what is known as the Closed Block.
Lapses
Long-Term Care
Non-Qualified Plan
Participating policies
98
Tax-free retirement accounts being proposed by the Bush administration (to replace IRAs). Individuals would be able to contribute up to $7,500 RSAs. While there is no maximum income limit for the accounts, an individual must have earnings to contribute to the account. A plan whereby contributions are qualified to be made on a pretax basis (like 403(b) and 457 plans) because the employee does not have access to a tax-deferral program like a 401(k) plan. An ordinance that went into effect on January 1, 2000, requiring life insurance companies to increase their reserves for certain term and universal life insurance policies. An ordinance that went into effect on January 1, 2003, requiring life insurance companies to increase reserves associated with no-lapse guarantees for UL. The ratio of capital held by an insurer to regulatory-required capital. The capital required by regulators is a function of product mix, asset composition, and other factors. Income earned on actuarial pricing like mortality risk on life insurance policies; morbidity risk on disability and long-term care policies; and losses on reinsurance business. Assets maintained independently from general account assets and back variable annuity and variable life products. The customer, not the insurance company, bears the investment risk and, as such, the capital requirements are minimal. The difference between investment income on assets backing spread-based products (like fixed annuities and GICs) and guaranteed interest credited. Spreads tend to widen in a rapidly declining interest rate environment when the yield curve is steepening because crediting rates drop faster than the overall yield on the investment portfolio. Surplus of assets over liabilities according to statutory accounting. Differs from GAAP capital because some GAAP assets (DAC, for instance) are not admitted under statutory accounting. Earnings according to Statutory Accounting Principals. Stat earnings are closer to cash earnings since expenses (particularly DAC) may not be deferred under stat accounting. Annuity used to provide periodic future payments stemming from the settlement of a lawsuit. Structured settlement payouts are often tax-advantaged to the claimant. Insurance policies that supplement one's primary health plans by providing cash benefits to policyholders for additional time or benefit coverage, costs not covered by traditional medical plans such as travel to and from treatment centers and other out of pocket expenses; and/or specific medical ailments. Features usually associated with life insurance policies whereby benefits are not paid until the "survivor" or both people on the policy dies. A feature typically used when the policy is being established to help fund estate taxes. The cost to a contract owner for early redemption of a contract. Typically a group fixed annuity used to fund a pension liability. Terminal funding is often used to fund pension plans that are discontinued due to bankruptcies, mergers or plant closures.
Qualified Plan
Regulation XXX
Regulation AXXX
Separate Accounts
Spread Income
Statutory Capital
Statutory Earnings
Structured Settlement
Supplemental Medical
Survivorship/Secondto-Die
99
Third Sector
A segment of the Japanese insurance market that represents the supplemental medical market. The first sector represents the life insurance and annuity market and the second sector represents the property/casualty market. A permanent life insurance policy that offers the policyholder more competitive crediting rates than a whole life policy, flexible premium payments and flexibility in adjusting the death benefit. Present value of future profits from insurance business acquired from another company. Similar to DAC (and unlike goodwill) VOBA must be amortized through earnings over time. An annuity contract in which the consumer has a choice of fixed rate returns where the company bears the investment risk or a number of variable rate options where the consumer bears the investment risk. In the variable rate options the consumer can choose from among a wide array of mutual fund options typically management by well-known asset managers. Income accumulates tax-free until annuitization when income is taxed at the ordinary income tax rate. Withdrawals before the age of 59 are subject to tax penalties. A type of permanent life insurance that provides death benefits and cash values that vary with the performance of an investment portfolio selected by the policyholder. The policy is sometimes set up in an irrevocable trust for beneficiaries to avoid estate taxes. A traditional life insurance policy whereby a death benefit is paid to the beneficiary at the death of the insured. A policyholder may pay premiums for either a specified number of years (limited payout) or for life (straight life). Premium amounts are fixed and crediting rates are typically modest making this product less attractive than other life insurance products. A process whereby policyholders take their money out of an investment product (i.e., variable and fixed annuities). Withdrawals are often subject to surrender charges.
Universal Life
Variable Life
Whole Life
Withdrawal
100
101
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Analyst Certification The research analyst who is primarily responsible for this research and whose name is listed first on the front cover certifies (or in a case where multiple analysts are primarily responsible for this research, the analyst named first in each group on the front cover or named within the document individually certifies, with respect to each security or issuer that the analyst covered in this research) that: (1) all of the views expressed in this research accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no part of any of the research analyst's compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst in this research.
JPMorgan Equity Research Ratings Distribution, as of December 31, 2003
Overweight JPM Global Equity Research Coverage IB clients* Financial Institutions - N. America & Latin IB clients* 37% 27% 36% 48% Neutral 43% 25% 38% 41% Underweight 21% 22% 26% 29%
*Percentage of investment banking clients in each rating category. For purposes of NASD/NYSE ratings distribution disclosure rules, our Overweight rating most closely corresponds to a buy rating; our Neutral rating most closely corresponds to a hold rating; and our Underweight rating most closely corresponds to a sell rating.
Legal Disclosures Lead or Co-manager: JPMSI and/or its affiliates acted as lead or comanager in a public offering of equity and/or debt securities for Hartford Financial Services, National Financial Partners, Principal Financial Group and Prudential Financial within the past 12 months. Director Disclosure: A senior employee or executive officer of JPMSI and/or its affiliates is a director of American International Group, MetLife and Prudential Financial. Investment Banking (past 12 months): JPMSI and/or its affiliates received in the past 12 months compensation for investment banking services from John Hancock Fincl Services, Lincoln National, MetLife, National Financial Partners, Prudential Financial and UnumProvident Corp. Investment Banking (next 3 months): JPMSI and/or its affiliates expect to receive, or intend to seek compensation for investment banking in the next three months from AFLAC, American International Group, Hartford Financial Services, Jefferson Pilot, John Hancock Fincl Services, Lincoln National, MetLife, National Financial Partners, Nationwide Financial Services, Principal Financial Group, Protective Life, Prudential Financial and UnumProvident Corp.
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