3 Speculative Bets In Insurance & Finance

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Big insurance and reinsurance companies have become prominent in the news. Are any of these stories positive for these stocks, and if so, are any of them trading at attractive prices that justify their purchase?

Prudential Projects Lower Portfolio Returns

Shares of the second largest American life insurer in the U.S., Prudential (NYSE: PRU), plummeted to a six month low when Prudential’s portfolio stock market return expectations were revised from 9 percent to 8 percent. The company recorded a net loss of $618 million in its third-quarter report, a result of costs related to currency-linked contracts and derivatives. The broad issue that is slamming the company is low portfolio returns, which means that Prudential and its shareholders are not getting much more from the firm’s investment portfolios than they need to pay out to claimants. Eric Berg, analyst for RBC Capital Markets said, “That’s a pretty heavy thing to say, that common stocks will permanently produce a lower rate of return than you had anticipated.”

Lowered expectations for stocks are absolutely terrible when combined low yields on fixed rate bonds. These fixed-income securities are almost on an all-time low and they are expected to remain that way until mid-2015, as pointed out by Mark Grier, Vice Chairman of Prudential Financial. He said, “Maintaining a reasonable relationship between fixed income returns and equity returns is appropriate. The risk premium in the market tends to be over a long period of time, fairly durable.”

Clearly, the outlook for Prudential and other life insurance companies is troubled.

Humana Pushes for Political Support

Many health insurance and health plan providers are concerned with the impact of new government involvement in healthcare.

Humana (NYSE: HUM) hopes that an ad campaign will reduce the tax burden it expects from Obama’s healthcare plan.  The Stop the HIT coalition of trade groups hopes to lower taxes from the Affordable Care Act which are set to be imposed on and the stakeholders involved in this sector. The insurance industry would pay an additional $84 billion in fees and taxes based on the Affordable Care Act. This increase is likely to prompt insurance companies to increase their premiums and cut the benefits. Heidi Margulis, a HUM senior vice president said, “I think you’ll hear more on the airwaves during this period of time, the lame duck, about the impact of the premium tax.” Because of the nature of the tax structure, the impact is expected to be greatly felt by the Medicare patients and small businesses.

It is very hard to ensure that the new tax system is fair and perceived as fair to all involved in the system. The spokesperson for Stop the HIT was not available for comments but the group describes itself as “a diverse group of trade and business associations.” It is made up of prominent bodies such as the National Association for Manufacturers and the United States Chamber of Commerce.

AIG to Sell Unit

American International Group (NYSE: AIG) is disposing of its 90% stake in International Lease Finance, a business unit that leases airlines. A group of Chinese investors will buy this stake for approximately $5.28 billion. Under the terms of the transaction, the group would acquire 80.1% stake in International Lease Finance for about $4.2 billion, with an option to buy an additional 9.9% stake in it. The Chinese investor group is led by the Chairman of New China Trust Weng Xianding and comprises of China Aviation Industrial Fund and P3 Investments.

The sale is hoped to be completed by the second quarter of 2013, pending U.S. regulatory approval. AIG is still a complex organization, but it is clearly streamlining its assets and its obligations.

During the financial crisis AIG received a $182 billion bailout from the government which it is trying to pay back by selling off parts of its business. Earlier, the government had 77% stake in AIG, which it is selling of gradually. As of September 30, 2012 the U.S. government owned 16% of the outstanding shares in the company.

More Disposals

ING (NYSE: ING) announced the disposal of its Malaysian insurance unit for 1.3 billion euros to AIA Group. This deal is likely to go through. Mark Tucker, AIA’s Chief Executive Officer took it upon himself to re-imagine the company's future after it had suffered a huge setback during the financial crisis. Tucker said that AIA is now strong enough that it can grow while simultaneously acquiring new assets calling it an “excellent strategic fit.”

Valuations

Health care providers and health insurance stocks (listed in italics) are trading at different valuations than other insurers:

<table> <tbody> <tr> <td> <p><strong><span>Ticker</span></strong></p> </td> <td> <p><strong><span>Company</span></strong></p> </td> <td> <p><strong><span>Country</span></strong></p> </td> <td> <p><strong><span>P/E</span></strong></p> </td> <td> <p><strong><span>P/S</span></strong></p> </td> <td> <p><strong><span>P/B</span></strong></p> </td> <td> <p><strong><span>P/</span><span>FCF</span></strong></p> </td> </tr> <tr> <td> <p><span>AIG</span></p> </td> <td> <p><span>American International Group</span></p> </td> <td> <p><span>USA</span></p> </td> <td> <p><span>2.52</span></p> </td> <td> <p><span>0.76</span></p> </td> <td> <p><span>0.53</span></p> </td> <td> <p><span>13.15</span></p> </td> </tr> <tr> <td> <p><span>BRK-A</span></p> </td> <td> <p><span>Berkshire Hathaway</span></p> </td> <td> <p><span>USA</span></p> </td> <td> <p><span>17.46</span></p> </td> <td> <p><span>1.49</span></p> </td> <td> <p><span>1.26</span></p> </td> <td> <p><span>21.23</span></p> </td> </tr> <tr> <td> <p><span>ING</span></p> </td> <td> <p><span>ING Groep</span></p> </td> <td> <p><span>Netherlands</span></p> </td> <td> <p><span>194</span></p> </td> <td> <p><span>0.65</span></p> </td> <td> <p><span>0.5</span></p> </td> <td> <p><span>NA</span></p> </td> </tr> <tr> <td> <p><span>LFC</span></p> </td> <td> <p><span>China Life Insurance</span></p> </td> <td> <p><span>China</span></p> </td> <td> <p><span>68.13</span></p> </td> <td> <p><span>1.69</span></p> </td> <td> <p><span>2.9</span></p> </td> <td> <p><span>5.55</span></p> </td> </tr> <tr> <td> <p><span>MET</span></p> </td> <td> <p><span>MetLife</span></p> </td> <td> <p><span>USA</span></p> </td> <td> <p><span>17.54</span></p> </td> <td> <p><span>0.58</span></p> </td> <td> <p><span>0.6</span></p> </td> <td> <p><span>2.78</span></p> </td> </tr> <tr> <td> <p><span>PUK</span></p> </td> <td> <p><span>Prudential</span></p> </td> <td> <p><span>UK</span></p> </td> <td> <p><span>15.16</span></p> </td> <td> <p><span>0.61</span></p> </td> <td> <p><span>2.53</span></p> </td> <td> <p><span>NA</span></p> </td> </tr> <tr> <td> <p><span>HUM</span></p> </td> <td> <p><span>Humana</span></p> </td> <td> <p><span>USA</span></p> </td> <td> <p><span>9.02</span></p> </td> <td> <p><span>0.28</span></p> </td> <td> <p><span>1.23</span></p> </td> <td> <p><span>NA</span></p> </td> </tr> <tr> <td> <p><span>AET</span></p> </td> <td> <p><span>Aetna</span></p> </td> <td> <p><span>USA</span></p> </td> <td> <p><span>8.66</span></p> </td> <td> <p><span>0.43</span></p> </td> <td> <p><span>1.4</span></p> </td> <td> <p><span>13.36</span></p> </td> </tr> <tr> <td> <p><span>CI</span></p> </td> <td> <p><span>Cigna</span></p> </td> <td> <p><span>USA</span></p> </td> <td> <p><span>10.45</span></p> </td> <td> <p><span>0.58</span></p> </td> <td> <p><span>1.65</span></p> </td> <td> <p><span>11.64</span></p> </td> </tr> <tr> <td> <p><span>UNH</span></p> </td> <td> <p><span>UnitedHealth Group</span></p> </td> <td> <p><span>USA</span></p> </td> <td> <p><span>9.92</span></p> </td> <td> <p><span>0.49</span></p> </td> <td> <p><span>1.74</span></p> </td> <td> <p><span>16.43</span></p> </td> </tr> </tbody> </table>

Outside of healthcare, AIG and ING are the cheapest based on low P/B ratios. They are also cheap on a revenue multiple basis. If investors can stomach the opacity of financial service companies, they should consider AIG and ING for small investments based on their low price multiples and their intentions to simplify their businesses.

Like most big financial service companies, AIG and ING are complex and probably too hard to really comprehend. One prudent course of action would be to swear off these companies altogether. If you have to have an allocation to financial companies, AIG and ING are cheap speculative bets.

Among health insurance and health plan companies, Humana is the cheapest based on valuation. No one really knows how the new healthcare regulations will be enforced, or what their consequences will be. This makes Humana a speculative bet at best.


BillEdson11 has no position in any stocks mentioned. The Motley Fool recommends American International Group. The Motley Fool owns shares of American International Group and has the following options: Long Jan 2014 $25 Calls on American International Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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