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About Everything: The Bullish Case for Life Insurance

The industry has been down, but its prospects are brightening.

 

Editor's Note: In this complimentary edition of About Everything, Hedgeye Demography Sector Head Neil Howe discusses why life insurance company shares have been beaten down since the Great Recession, but makes the case for their comeback. "Looking forward, there are a lot of positive trends at play. Gen Xers are waking up late to save for retirement, while risk-averse Millennials are trying to prepare early, promising to drive demand steadily upward for decades to come," Howe writes.

 

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WHAT’S HAPPENING?

The life insurance industry has problems.

 

Or at least, what’s left of it has problems. In 1988, there were 2,343 U.S. life insurers, but by 2014 that number had plunged to a mere 830.

 

Sure, giants like MetLife, Prudential, Manulife, and AIG still have hundreds of billions in total assets. But investors have soured on these companies since the Great Recession. Manulife’s stock prices have dropped by two-thirds since the end of 2007. Industry heavyweight MetLife still sits well below its pre-recession peak. Lincoln Financial has lost a quarter of its value in the past year alone. As for the remains of AIG, they are in danger of being dismembered and devoured. 

 

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Earnings season sure didn’t help these companies’ stock prices. Prudential saw its total revenue slide more than 4 percent year over year. AIG badly missed Wall Street’s estimates, tallying just $0.65 in operating income per share (compared to a consensus $1.00). MetLife’s YOY earnings, meanwhile, plunged a full 9 percent.

THE BAD NEWS: MOSTLY IN THE PAST

So yes, this industry has its issues, but they’re well-known—and are already priced into the market.

 

“Minimum return guarantees.” Today’s life insurers are hamstrung by yesteryear’s optimism. Moody’s estimates that guaranteed products—whether life insurance policies or annuities—make up as much as 80 percent of insurers’ balance sheets. Most of these products carry a minimum payout of 3 percent or more.  

 

What’s wrong with that? Nothing, if it’s the 1980s and the rate on 10-year treasuries is bobbing around near double digits. But today, with long-term rates sinking toward zero, these guaranteed payouts are a bleeding wound.

 

The “interest-rate risk” triggered by imbedded guarantees is greatest for fixed annuities, which are often locked into a single rate of return over the life of the product—as well as for “universal life” policies that accrue cash value at a fixed rate.

 

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Demutualization. In the old days, the big mutually owned (or privately held) life insurance companies could keep their eye fixed on long-term returns. These firms could match long-term obligations with long-term assets without listening to what bean-counters might say about the changing net worth of their companies quarter to quarter.

 

But all that changed during the bubbly exuberance in the late ‘90s, when insurers from MetLife to Prudential thought they would be worth a lot more if they went public. And now these companies are saddled with the result: investors who constantly want to know what their stock is worth now, now, now.

 

In search of a higher immediate return that they could advertise to their shareholders, these newly public insurers have turned to riskier asset classes. In 2004, corporate and government bonds made up 74 percent of life insurance portfolios—a share that slid to 58 percent by 2014. Now more than ever, their assets rise and fall with each market swing—and there’s clearly been much more falling than rising going on lately. 

 

“Too-big-to-fail” regulations. In 2014, under Dodd-Frank rules, three of the biggest life insurers by assets (MetLife, AIG, and Prudential) were classified as “systemically important financial institutions” (SIFIs)—meaning they had to meet liquidity requirements and hold more capital on hand than your average life insurer. MetLife has since wiggled out from under its SIFI categorization, perhaps opening up the door for the others to follow suit.

 

Competition from other savings vehicles. According to consultancy LIMRA, sales of life insurance policies have declined 45 percent since the mid-‘80s. Today, roughly 30 percent of American households today have no life insurance at all (not even a term policy)—up from 19 percent three decades ago. Most of this decline has been in “whole life” policies with a strong savings component.

 

Why? Competition. A century ago, life insurance was the only way a typical American family could save anything for the future. Then we added Social Security. Later we added defined-benefit pensions. And still later we added a whole array of voluntary options, from 401(k)s to IRAs. These retirement savings vehicles aren’t just plentiful: They’re efficient, easy to use, low-cost, and (often) tax sheltered.

THE GOOD NEWS: IN THE FUTURE

Sure, in the near future, life insurance will continue to suffer from its legacy problems—guarantees that are “in the money” plus competition from other forms of tax-free savings. But firms that can manage these challenges have a lot to look forward to.

 

The retirement savings crisis. By any measure, working-age Americans are saving far too little to retire when they plan to or with as much as they need—and they’re just beginning to wake up to that fact.

 

The National Retirement Risk Index shows that more than half of Americans aren’t putting away enough to retire without a steep drop in living standards. 

 

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Of these non-savers, a huge share belong to Generation X. The 35- to 54-year-old demographic now populated by Xers has seen its median household financial assets slide since 1989. 

 

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And what’s worse is what’s left after all the new debt they’ve accumulated. Median household net worth has downright plummeted. Back in 1989, the typical 35- to 44-year-old household had a net worth about $100,000 (in today’s dollars). Now it’s below $50,000. Net worth among 45- to 54-year-olds have dropped by nearly half as well. 

 

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How is this generation ever going to retire? Keep in mind that public retirement benefits are going to become stingier, not more generous, in the years to come—as today’s breaking age wave puts ever more pressure on Social Security, Medicare, Medicaid, and related programs.

 

My conclusion: Gen-Xers will have no choice but to ramp up their savings steeply in the years ahead. And much of these new savings will flow into products offered by the life insurance industry. Indeed, over the last three years the personal savings rate has already been rising. This rise will continue—putting some deflationary drag on the economy as a whole, perhaps, but enabling millions of 40- and 50-something households to repair their balance sheets.

 

Low rates of return. Life insurance execs complain a lot about low long-term rates—not just because of the hit they take in guaranteed payouts, but also because they think it makes their products look unattractive. These worries are unfounded. Quite simply, everything looks unattractive nowadays. 

 

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In fact, low rates could easily cause people to save more. In the short run, sure, low interest rates suppress savings. But in the long run—once everyone expects low rates to continue indefinitely—the correlation reverses. (The world’s ZIRP-  and NIRP-fixated central bankers have yet to figure this out.) Households and pension funds eventually realize they must put away ­more money each year to hit their retirement targets. Plus, workers in a low-interest-rate environment can’t count on their own income to grow as fast in the future—which further boosts the need for extra savings.

 

Favorable demographics. From the ‘90s onward, Boomers moving into midlife have helped push much of the life insurance industry away from its traditional whole-life product line and toward various kinds of annuities. Now, as Boomers move past age 65, that strong demand for annuities is fading.

 

Meanwhile, the demographic tide is about to turn. Census population projections show that, over the next fifteen years, Millennials will swell the ranks of 30- to 39-year-olds and then the ranks of 40- to 49-year-olds. This will provide a much-needed boost in demand for traditional life insurance. 

 

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Generational change. More than just their sheer number, Millennials’ cautious worldview will fuel even greater demand for life insurance.

 

For starters, they’re already saving as much as possible to avoid falling into the quicksand of retirement catch-up that they’ve seen happen to so many of their parents. In this effort, life insurance is one more way to save.

 

But life insurance isn’t just another savings vehicle for Millennials. This generation also wants to be protected from risk—which is the name of the game for life insurers. For Millennials, there’s no such thing as “playing it too safe.” Many are already buying whole-life insurance well before the age at which they’re likely to use it. In the workplace, they’re fueling new demand for voluntary life insurance policies that will keep their loved ones solvent no matter what happens. Among workplace benefits, according to a 2015 survey by the Employee Benefit Research Institute, Millennials are the only generation that regards life insurance as important as retirement savings.

 

It’s not just married Millennials, either. Some single twentysomethings are taking out policies as well, just in case—presumably to reimburse Mom and Dad for all those years of rent-free living.

 

In fact, insurers could even leverage this need for protection into a service that walks Millennials through everything they need to know about finance—in which life insurance is just one piece of the puzzle. Look no further than Massachusetts Mutual’s “Society of Grownups,” a program chalk-full of whole-life advice for prudent young consumers. (The tagline: “Helping you find your inner adult.”)

 

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TAKEAWAYS

  • Up until recently, life insurers have been plagued by difficult challenges. Their guaranteed products have left them vulnerable to “in the money” payouts. They’ve also been pressured to prove profitability to their shareholders amid a long-term slide in the demand for their flagship products.
  • But looking forward, there are a lot of positive trends at play. Gen Xers are waking up late to save for retirement, while risk-averse Millennials are trying to prepare early, promising to drive demand steadily upward for decades to come.

[UNLOCKED] Fund Flow Survey | The Biggest Inflow Into Cash Products Since 2008

Takeaway: ICI's recently published annual Factbook shows 2015 as the biggest annual inflow for money markets since 2008. FII printed record EPS in '08

Editor's Note: Below is a complimentary research note originally published June 2, 2016 by our Financials team. If you would like more info on how you can access our institutional research please email sales@hedgeye.com.

 

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Record earnings for a Financial company that is not an exchange? Survey says...only a handful...however Federated Investors (FII) is headed in that direction. With the diversification of the business into industry leading equity (and a few fixed income products) that are back stopping the challenged money fund business, the firm is a prime beneficiary of a "not too hot but not too cold" environment.

 

That said, the firm's core business is about to get another shot in the arm and the positioning is nicely paired off. If the Fed hikes rates into the back half of the year, the $260 billion in money fund assets at FII gets more profitable. Another +25 basis point increase takes operating income up $8 million annually or +$0.08 in annual EPS. If the economy slows and investors rush back to cash, then the company increases that $260 billion cash balance substantially. If the Fed hikes into a slowdown (drum roll please), then FII increases BOTH pricing and volume.

 

The company is a late cycle stock either way having put up record earnings in 2008 of $2.23 per share with a stock price that increased throughout both the Tech Wreck in 2000 and also the Financial crisis of 2007. The latest ICI annual FactBook outlines that 2015 was the biggest inflow into cash products (+$21 billion) since 2008.  

 

[UNLOCKED] Fund Flow Survey | The Biggest Inflow Into Cash Products Since 2008 - Cover chart

 

[UNLOCKED] Fund Flow Survey | The Biggest Inflow Into Cash Products Since 2008 - Cover II

 

Investment Company Institute Mutual Fund Data and ETF Money Flow:

International equity mutual funds missed a 3 week winning streak, with a -$1.0 billion outflow in the 5-day period ending May 25th. What has not been volatile however is domestic equity mutual funds which have been consistently soft, giving up -$5.2 billion this week alone with a -$3.0 billion weekly redemption thus far in '16. In fixed income, high yield and global mutual funds experienced -$321 million and -$1.8 billion in drawdowns while investment grade, other, and muni bonds brought in +$1.9 billion, +$2.2 billion, and +$1.5 billion respectively. Municipal bonds are leading the pack in fixed income, with the best start on record for the 21 weeks of 2016. ETF flows were fairly flat this week with equity funds bringing in +$280 million and bond funds gathering +$522 million. Finally, investors shored up a resounding +$14 billion in money funds/cash last week, the 3rd biggest weekly cash build of 2016.


[UNLOCKED] Fund Flow Survey | The Biggest Inflow Into Cash Products Since 2008 - ICI19

 

In the most recent 5-day period ending May 25th, total equity mutual funds put up net outflows of -$6.3 billion, trailing the year-to-date weekly average outflow of -$2.3 billion and the 2015 average outflow of -$1.6 billion.

 

Fixed income mutual funds put up net inflows of +$3.5 billion, outpacing the year-to-date weekly average inflow of +$2.4 billion and the 2015 average outflow of -$475 million.

 

Equity ETFs had net subscriptions of +$280 million, outpacing the year-to-date weekly average outflow of -$1.4 billion but trailing the 2015 average inflow of +$2.8 billion. Fixed income ETFs had net inflows of +$522 million, trailing the year-to-date weekly average inflow of +$1.5 billion and the 2015 average inflow of +$1.0 billion.

 

Mutual fund flow data is collected weekly from the Investment Company Institute (ICI) and represents a survey of 95% of the investment management industry's mutual fund assets. Mutual fund data largely reflects the actions of retail investors. Exchange traded fund (ETF) information is extracted from Bloomberg and is matched to the same weekly reporting schedule as the ICI mutual fund data. According to industry leader Blackrock (BLK), U.S. ETF participation is 60% institutional investors and 40% retail investors.



Most Recent 12 Week Flow in Millions by Mutual Fund Product: Chart data is the most recent 12 weeks from the ICI mutual fund survey and includes the weekly average for 2015 and the weekly year-to-date average for 2016:

 

[UNLOCKED] Fund Flow Survey | The Biggest Inflow Into Cash Products Since 2008 - ICI2

 

[UNLOCKED] Fund Flow Survey | The Biggest Inflow Into Cash Products Since 2008 - ICI3

 

[UNLOCKED] Fund Flow Survey | The Biggest Inflow Into Cash Products Since 2008 - ICI4

 

[UNLOCKED] Fund Flow Survey | The Biggest Inflow Into Cash Products Since 2008 - ICI5

 

[UNLOCKED] Fund Flow Survey | The Biggest Inflow Into Cash Products Since 2008 - ICI6



Cumulative Annual Flow in Millions by Mutual Fund Product: Chart data is the cumulative fund flow from the ICI mutual fund survey for each year starting with 2008.

 

[UNLOCKED] Fund Flow Survey | The Biggest Inflow Into Cash Products Since 2008 - ICI12

 

[UNLOCKED] Fund Flow Survey | The Biggest Inflow Into Cash Products Since 2008 - ICI13

 

[UNLOCKED] Fund Flow Survey | The Biggest Inflow Into Cash Products Since 2008 - ICI14

 

[UNLOCKED] Fund Flow Survey | The Biggest Inflow Into Cash Products Since 2008 - ICI15

 

[UNLOCKED] Fund Flow Survey | The Biggest Inflow Into Cash Products Since 2008 - ICI16



Most Recent 12 Week Flow within Equity and Fixed Income Exchange Traded Funds: Chart data is the most recent 12 weeks from Bloomberg's ETF database (matched to the Wednesday to Wednesday reporting format of the ICI), the weekly average for 2015, and the weekly year-to-date average for 2016. In the third table are the results of the weekly flows into and out of the major market and sector SPDRs:

 

[UNLOCKED] Fund Flow Survey | The Biggest Inflow Into Cash Products Since 2008 - ICI7

 

[UNLOCKED] Fund Flow Survey | The Biggest Inflow Into Cash Products Since 2008 - ICI8

 

Cumulative Annual Flow in Millions within Equity and Fixed Income Exchange Traded Funds: Chart data is the cumulative fund flow from Bloomberg's ETF database for each year starting with 2013.

 

[UNLOCKED] Fund Flow Survey | The Biggest Inflow Into Cash Products Since 2008 - ICI17

 

[UNLOCKED] Fund Flow Survey | The Biggest Inflow Into Cash Products Since 2008 - ICI18



Net Results:

The net of total equity mutual fund and ETF flows against total bond mutual fund and ETF flows totaled a negative -$10.0 billion spread for the week (-$6.0 billion of total equity outflow net of the +$4.0 billion inflow to fixed income; positive numbers imply greater money flow to stocks; negative numbers imply greater money flow to bonds). The 52-week moving average is -$2.0 billion (negative numbers imply more positive money flow to bonds for the week) with a 52-week high of +$20.2 billion (more positive money flow to equities) and a 52-week low of -$19.0 billion (negative numbers imply more positive money flow to bonds for the week.)

  

[UNLOCKED] Fund Flow Survey | The Biggest Inflow Into Cash Products Since 2008 - ICI10

 


Exposures:
The weekly data herein is important for the public asset managers with trends in mutual funds and ETFs impacting the companies with the following estimated revenue impact:

 

[UNLOCKED] Fund Flow Survey | The Biggest Inflow Into Cash Products Since 2008 - ICI11 


Daily Market Data Dump: Wednesday

Takeaway: A closer look at global macro market developments.

Editor's Note: Below are complimentary charts highlighting global equity market developments, S&P 500 sector performance, volume on U.S. stock exchanges, and rates and bond spreads. It's on the house. For more information on how Hedgeye can help you better understand the markets and economy (and stay ahead of consensus) check out our array of investing products

 

CLICK TO ENLARGE

 

Daily Market Data Dump: Wednesday - equity markets 6 8

 

Daily Market Data Dump: Wednesday - sector performance 6 8

 

Daily Market Data Dump: Wednesday - volume 6 8

 

Daily Market Data Dump: Wednesday - rates and spreads 6 8

 

Daily Market Data Dump: Wednesday - currencies 6 8


Early Look

daily macro intelligence

Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.

CHART OF THE DAY | Neck & Neck: Trump vs. Clinton

Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye Director of Research Daryl Jones. Click here to learn more.

 

"... Settings aside something coming from left field (or an errant email server), this race is down to The Donald versus Hillary. As of this morning and as you can see in the Chart of the Day, the pollsters are basically showing it to be a statistical tie. To the chagrin of many, the Donald is in it to win it and has a real chance to do so. The next 5 months may have to be the grittiest and most determined of Hillary Clinton’s political life."

 

CHART OF THE DAY | Neck & Neck: Trump vs. Clinton - 06.08.16 EL Chart


First of Many HHS Budget Updates; Postitive-MA Plans, Drugs & Services; Negative-Insurers

Takeaway: A Senate Appropriations Subcommittee approved FFY 2017 HHS spending; IBAP zeroed out, more money for OMHA & NIH, Bad News for Risk Corridors

This afternoon, the Labor, Health and Human Services and Education subcommitee approved the FFY 2017 HHS spending plan. Tonight's approval marks the first time since FFY 2008, the upper chamber's subcommittee has accomplished this feat. With several Senators in close races, the need to accomplish something in a bipartisan and effective manner overwhelmed the usual inertia.

 

We are still early in the process, of course, but there are a few things in this vote worth mentioning:

 

Zero funding for IPAB accompanied by this explanation in the Chairman's press release:  "Funding for IPAB is eliminated.  IPAB is a 15 member board of unelected bureaucrats created by the ACA to achieve a reduction in Medicare spending through the only means they have – rationing care." 

 

Now, a spending deal for FFY 2017 won't get finalized before the Office of the Actuary has to report to the Secretary of HHS whether or not IPAB is triggered, giving today's vote limited power to calm the angst that might occur between now and the end of July. So, for what it is worth, our view is that the Office of the Actuary will report to the Secretary that IPAB is not triggered. We believe that because the law affords HHS a bit of discretion in calculating the Medicare per capita growth rate. Specifically, the Office of the Actuary can "take into account any delivery system reforms or other payment changes that have been enacted or published in final rules but not yet implemented as of the making of such [Medicare per capital growth rate] calculation." Given the pace of reform at HHS, that is a whole lot of stuff that gets taken into consideration.

 

If we are wrong, the vote today and what we anticipate will be complete agreement from the rest of the Senate and the House, will serve as a backstop. The zero funding of IPAB is good news for all health care but particularly Medicare Advantage Plans and drug manufacturers.

 

Increased funding of $5 million for the Medicare Office of Hearings and Appeals. The next steps in a lawsuit between the American Hospital Association and HHS depend on getting the backlog of appeals (mostly attributable to the Recovery Audit Program) under control. If HHS cannot, it could be bad news for HMSY, COTV, PFMT and GIB if the court is forced to intervene with a writ of mandamus. See more on that issue here.

 

Increased funding for NIH. An increase of $2 billion for Alzheimer's, Precision Medicine research and combatting drug resistant antibiotic drugs among other things. This is the second big year in a row for NIH funding. The impacts are not immediate but should be long lasting in the form of breakthrough medicines and other therapies.

 

Budget Neutrality for Risk Corridor Program. This marks year three for the budget neutrality language for the risk corridor program. Some insurance companies had been optimistic last year and HHS even suggested they would look for ways to make insurers whole. Not gonna happen. Ever. So, everyone is suing. This legislative action makes success in court, pretty unlikely, however.

 

Full text will be available at full committee mark-up on Thursday. Riders may be considered then so we will keep you posted as things unfold.

 

 

 

 

 

 


NOC Seeing the Pinch of the Bomber Win?

Takeaway: NOC CEO's statement he is "biasing more of our capital" inside NOC could be early indicator of future reduced margins as result of LRS-B win

In widely reported public remarks made at a sell-side research conference in NYC last Friday, CEO Wes Bush stated that he is "now biasing more of our capital toward the investments inside our company."  He also acknowledged that new development programs can come with lower profit margins without getting program specific. 

While Bush's remarks are being characterized as heeding Pentagon pressure for defense industry to increase its own R&D spending, we believe that they are actually a manifestation of some of the downside of NOC's $80B win to develop and build the B-21 Long Range Strike bomber.  

In our note of 2 March, "Good, Bad and Ugly for NOC on Bomber"  we identified the following perils:

  • Senator McCain, Senate Armed Services Committee chairman, has come out stridently against the cost-plus nature of the development contract awarded by the Air Force to NOC.  McCain is a dangerous enemy who similarly opposed the contract vehicle the USAF originally wanted to use with BA for the KC-46 tanker and that began the 8+ year delay now seen by that program, resulting in nearly $2B in charges by BA. 
  • While a change in the B-21 contract format at this point seems improbable, a cost cap imposed by Congress is almost a sure thing.  The device has become standard practice in Congress’ handling of Navy shipbuilding.  The point of the cap is to pressurize the Air Force so that it will pressurize NOC as if it were a fixed price contract. 
  • While the cost of the B-21 development is budgeted for $23.8B, that is almost certainly not what was actually awarded by the Air Force to NOC. Transparency in the contract amount is currently being debated in Congress but indications are that bids from both Northrop and Boeing were much lower than the Government’s independent cost estimate.   
  • With a cost cap on what must have been a very aggressive bid by NOC and a contract award that appears to be significantly less than what an independent cost estimate has said development will cost, NOC margins are likely to be greatly pressurized in order to keep the B-21 program on track.
  • NOC’s firm fixed price production bid also carries risk since it must have been based on NOC’s view of the design and development of the B-21. Given the higher independent cost estimate and budget requests, the government obviously has a different view of the risk and costs of NOC’s design than estimated by NOC.  Changes in the design during the development phase for whatever reason are bound to result in changes in the production cost.  
  • With all of this pressure to perform on the B-21 and still maintain company margins, NOC is going to be challenged to be competitive on new programs.  For example, NOC has been working for some time on a clean sheet design bid for this fall’s $8B Air Force T-X trainer competition (LMT, RTN and BA are the other bidders). 

 


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.32%
  • SHORT SIGNALS 78.48%
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