Bright outlook for lifecos grows dim
We see no action on dividends until next year at the earliest
Canada’s life insurance companies can’t seem to catch a break as stubbornly low interest rates continue to hamper earnings six years after the hard crash of the financial crisis.
Most of Canada’s lifecos will begin reporting their secondquarter earnings next week, with analysts saying that a decline in interest rates during the three-month period will likely bite into profits. Insurance companies are heavily dependent on fixed-income investments.
“There would appear to be a strong consensus that interest rates are headed higher, but rates are down meaningfully so far this year,” said Robert Sedran, analyst at CIBC World Markets.
“Equity markets have been better than expected, but the divergence between that performance and the bond market is at the very least something to watch.”
The picture seemed to be brightening for lifecos last May, when the U.S. Federal Reserve first began hinting that it would scale back its massive bond buying program — a program that has kept long-term interest rates at record lows. The news led to a temporary spike in bond yields and a flood of investors poured into lifecos looking to capitalize.
Last year, life insurance stocks on the S&P/TSX Composite climbed 44%, making it among the best performing sectors and representing the biggest gains for insurers since the financial crisis.
Unfortunately, gains have been slower to come by this year. The life insurance segment is up only 3% year-todate, trailing the TSX’s more than 12% return for 2014.
But it is not an entirely bleak picture for Canada’s life insurance companies. The big players such as Manulife Financial Corp., Great-West Lifeco and Sun Life Financial Co. are in a much stronger position as far as capitalization and diversification are concerned, points out Mr. Sedran. Life insurers were one of the heaviest hit when markets crashed in 2008, ex- posing issues over leverage and capital levels and leading many companies to spend the next few years decreasing their risk.
That fundamental restructuring should help lifecos this year, even if interest rates remain stubbornly low.
“We believe that even in the current environment, they should still be able to grow net income — helped by higher assets under management and recent sales trends — and so we expect better core results out of the group for the remainder of the year,” he said. “Our estimates for the quarter call for an average 7% quarter-over-quarter and 19% year-over-year increase in earnings, excluding the impact of market variables.”
Much of that earnings growth will be helped by the strong performance of stock markets for the quarter. Many insurance companies also sell mutual funds and other equity products to customers, meaning they benefit from stock price increases as well.
Barry Schwartz, chief investment officer and portfolio manager for Baskin Financial in Toronto, said he continues to like insurance companies, despite the performance of interest rates this year. He said he favours Power Corp. of Canada and American International Group Inc. as his top picks, noting that U.S. insurance companies in particular are cheaper than their Canadian counterparts.
“We’re fans of them, because at the end of the day, we’re moving toward higher rates,” he said. “I think we’re also close to dividend hikes from some of the lifecos and the market smells that.”
Many insurance companies cut their dividends following the financial crisis and unlike Canada’s banks, which have been hiking dividends steadily throughout the past year, have not returned money to shareholders on that front.
Mr. Sedran also sees dividends around the corner, but he notes that it is unlikely any hikes will be announced this year, given the murky picture on interest rates.
“We see no action on dividends until next year at the earliest,” he said.