Description

Life insurance stocks have been hit hard in the past 3-6 months due largely to continued interest rate weakness. I want to make the case that life insurance stocks, especially VOYA (and LNC), are trading at extreme risk-adjusted discounts. The extreme discount more than compensates investors for the lack of a near term "fast money" catalyst.

[4/11/2015 LNC Writeup Update: Fundamentals Remain Strong LT] 

To illustrate the disconnect in the market I will compare the energy industry's risk/reward to the insurance industry's risk/reward. I chose energy as a comparison because both energy and insurance companies are sensitive to market fluctations (energy prices and interest rates/equity markets). Additionally, both industries have recently experienced adverse market price movements. Finally, both business models have some interesting similiarities and differences that make the comparison particularly illuminating.

So why VOYA?

First, the company has the financial flexibility and authorization to buy back $700m of its stock. Based on this authorization, VOYA share price declines are good news for long-term investors. 

Second, the market appears to be assigning a negative value to a $5b closed block of variable annuities (11% surrender rate). At the end of January when the S&P was at 1,940 management confirmed that the the assets supporting the block were in excess of the liabilities. Additionally, the company has hedges to protect against a relatively wide range of equity market outcomes so the actual risk posed to VOYA's capital appears to be managable. Given the 11% surrender rate, this block of business is unlikely to material issue for the company long-term.  

Third, the company's turnaround efforts seem to be working. 2015 ongoing business adjusted operating ROE increased to 12.2% in 2015 from 11.7% in 2014. The company is targeting a 13.5-14.5% ROE by 2018. Several things are keeping ROE low right now: 1) flat equity market performance; 2) Depressed interest rates; 3) A $350m strategic investment that will generate approximately $35m in net annual cost savings by 2018. 

Fourth, its core business continues to generate strong results: 1) Retirement continued its positive momentum in most sub-segments in 2015; 2) Fixed annuity sales were +10%, investment only products were also up 10% in 2015; 3) Investment management sales growth was roughly flat in 2015 due in part to the weak equity market performance; 4) Employee benefits: +14% in force premium growth; 5) Slight negative: VOYA's relatively small life insurance business is average at best. It relies primarily on "alligned distributors" who then promote VOYA's products to independent agents. Naturally independent agents have little to no loyalty to any one insurance company. As a result, the model's upside is somewhat limited. 

ST Valuation: I will borrow Deutsche Bank's valuation as it seems to be reasonable: $44 sum of the parts - ongoing business ($32), CBVA ($3), and the DTA NPV ($8). What matters more than VOYA's current valuation is what the company will be several years from now post-CBVA hangover. If the management team can pull off even half of its targeted ROE improvements the company's valuation will likely be much higher. Furthermore, any improvement in the interest rate outlook will help VOYA's valuation. 

LT Valuation: The company has a clear path to: A) Higher volumes due to global growth and distribution strength; B) Reasonable risk-adjusted returns on the products they sell due to stable barriers to entry within the insurance industry.  

Risk: insurance companies are by nature highly leveraged at least from an asset standpoint. The leverage is considered safe because historic impairments as a percentage of assets tend to be <1%. Even in 2008, impairments were only 1.3% of assets (easily could have been much worse had the crisis continued for another 6-12 months). Given the signifciant expansion in corporate credit this cycle and the rising risks in China and other parts of the world, a scenario with outsized credit losses could cause a high number of insurance company failures.

VOYA has above average financial strength but is no where near insurance companies like New York Life and Northwestern Mutual. VOYA's primary protection comes from being: A) Large with potentially better access to capital in the event of a crisis (fingers crossed); B) In a crisis scenario, regulators will "fail" the bottom quartile of companies beforer working their way up the chain. As a result, I am comfortable with VOYA's ability to survive a financial crisis.  

Catalyst

1) Rates going up (hopefully sometime in the next 5 years); 2) Equity market gains (probable over the long-run); 3) Ongoing ROE improvement; 4) CBVA wind down.