Key themes
Financial market recovery and non-life upturn
debates aside, we believe European insurance
share price performance will be dominated by
four key investment themes in 2009. These are:
􀀗 announcement and execution of credible costcutting
initiatives – a new theme we explore
􀀗 ongoing capital adequacy pressures which
could trigger insurance capital raising outside
Holland – we update our analysis
􀀗 Insurers’ ability to illustrate cash flow
generation – this is an increasingly important
valuation metric
􀀗 rising corporate bond defaults will hit
earnings and solvency levels for a sector that
is 29% corporate bond invested on average or
60% in extreme cases. But there might be
some respite from higher reported book
values should corporate bond yields fall
This report covers these four themes in an attempt
to identify the potential risks and rewards across
our 24 stock coverage universe.
i) Huge cost-cutting potential exists
Our in-depth analysis of 49 European insurers’
expense bases identifies EUR13bn of
administrative cost-cutting potential in our base
case and EUR36bn in our bull case.
Successful execution of estimated cost-cutting
potential could create value between EUR26bn in
our base case or EUR100bn in our bull case.
Total communicated cost-cutting plans equate to
just 38% of the base case and 12% of the bull case
potential we identify for our coverage universe.
Our analysis highlights the least efficient insurers
operating with administrative expense ratios some
7x higher than the most efficient. We believe
insurers’ should operate with similar
administration expense ratios and big differences
in lieu of company explanations imply costcutting
potential.
We believe groups with the biggest cost-cutting
potential (value creation measured as a percentage
of current share price) within our coverage
universe are: AEGON, Standard Life, Prudential,
Euler Hermes, Fondiaria-Sai, ZFS, AXA and
Allianz, as Exhibit 1 summarises.
Our analysis draws a number of
conclusions including:
􀀗 the largest insurers are still failing to extract
meaningful economies of scale benefits,
implying material cost-cutting potential at
large-caps AXA and Allianz
􀀗 back-office duplication also remains rife in
the sector although some insurers are
aggressively addressing this (i.e. Mapfre,
Aviva, Baloise).
􀀗 Paradoxically, the broker-driven Lloyd’s
vehicles score poorly from an administration
expense ratio perspective. We would have
expected a high acquisition and low admin
expense ratio for a broker-led model.

Although we expect a plethora of cost-cutting
announcements this year, this could be tempered
by union constraints and management appetite.
We also try to highlight those groups that may
have achieved impressive administrative
efficiency rankings through expense shifting.
ii) Capital adequacy concerns
Our solvency analysis reveals our coverage
universe has a EUR48bn buffer (21% market cap)
above ‘AA’ target requirements.
Unsurprisingly, reinsurers are better capitalised
than primary insurers, life better than non-life in
our base case, but non-life insurers are more
resilient than life insurers in our bear case.
On a more worrying note, Aviva, Euler Hermes,
Friends Provident, Prudential, Standard Life and
ZFS have absolute capital levels close to existing
credit rating requirements, raising fears of capital
raising or downgrades.
Our analysis highlights six insurers would have to
raise only a combined EUR2bn (4% of related
market cap) in our base case and 13 insurers
would have to raise a combined EUR30bn (18%
of related market cap) in our bear case for capital
levels to be consistent with existing ratings.
However, rating agencies consider a range of
additional criteria (dividend policy, earnings track
record, financial flexibility, growth plans and
enterprise risk management) in rating assessments
which may mitigate (or accelerate) the risks of
capital raising or rating downgrades. For example:
􀀗 our earnings estimates imply a 22% fall in
2009/07 and a 11% fall in 2010/07,
on average
􀀗 Dividend cuts could become an increasingly
important capital preservation lever. Our
universe would preserve EUR13bn (6%
market cap) if companies did not pay the final
or full 2008 dividend
􀀗 Aviva, Euler Hermes and ZFS’ capital levels
would be consistent with existing AA ratings
in our base case if management decided not to
pay a final or full 2008 dividend
iii) Adequate cash cover of dividends
may not be enough
The sector currently trades at an attractive 6.4%
dividend yield, significantly above 10-year
government bond yields. We estimate operating
cash flow cover of dividends remains adequate at
1.7x, with non-life biased insurers having the
highest cover on average.
Swiss Re, AXA, Allianz, Fondiaria-Sai and
Generali have higher-than-average dividend cover
ratios, and of these only Swiss Re (8.5%), Allianz
(8.2%) and Fondiaria-Sai (9.7%) have among the
highest 2008e dividend yields.
In our view, this suggests insurers need to illustrate
their ability to generate cash better, particularly since
investors are paying closer attention to sustainable
future cash flows and using cash flow multiples or
yields as a valuation metric.
Short term, however, capital buffers will dictate
dividend payouts rather than cash flow
generation; although when rebasing (to other than
zero) management will be mindful of operating
cash flow generation.
iv) Credit concerns
Corporate bond defaults will be an important
share price driver in 2009 for several reasons:
􀀗 spreading of the credit crisis into the broader
economy could lead to an acceleration of
defaults, particularly since non-financial
institutions are unlikely to be given the same
level of government support as financials

􀀗 corporate bond defaults, unlike revaluation
reserve movements, negatively affects
earnings as well as rating agency and
regulatory capital buffers
􀀗 corporate bonds account for 29% of insurance
sector invested assets (vs. 8% for equities),
although this is as high as 60% in some cases.
􀀗 European insurers’ gross corporate bonds
investments accounts for 2.9x shareholders’
funds on average (or 1.7x shareholders’ funds,
net of policyholder participations and tax).
Our most pessimistic scenario weighted according to
credit profile implies corporate bond defaults
equating to 11% of AEGON’s market cap and 5% of
Prudential’s which is hardly surprising given high
gross asset gearing, relatively low quality
holdings and limited policyholder participation
buffers. Both insurers’ portfolios also have a US
skew where 80% of defaults occurred last year.
However, some investors may contend with our
treatment of Prudential’s relatively high
proportion of non-rated bond holdings as below
investment grade.
Un-quantified hedging and reduced single
exposure limits in light of the ‘fallen angels’
debacle may provide an invaluable offset although
there has been limited evidence of this following
Lehman’s collapse.
Insurance shareholders’ ‘modest’ exposure
(unlike banking sector) to the most critical ABS
will continue to be topical although it is ‘capital
deductive’ impairment charges rather than the
negative revaluations which we fear. We estimate
that our coverage universe has EUR98bn of
critical ABS investments on their balance sheet
but shareholders ultimate exposure is a far more
modest EUR58bn if we net out tax and Life
policyholder participation which acts as a
significant buffer.
How to play the sector
The European insurance sector is attractively
valued but we believe the sector will struggle to
perform in an environment where equities remain
volatile, long- and short-term interest rates remain
below historical averages and corporate bond
yields remain high. These have historically been
poor conditions for insurance share price
relative outperformance.
Capital adequacy, dividend sustainability
macroeconomic and financial market sensitivities
will in our view continue to dominate European
insurance share price performance. However,
credible cost-cutting announcements, which go
some way to meeting the potential we have
identified, could help when insurers’ earnings are
being attacked on multiple fronts.
Insurance investors should continue to hold a
well-diversified portfolio in this context rather
than simply an exclusive bias to non-life /
defensive names.
We favour insurers with high-quality management
teams, adequate capital buffers, realistic dividend
expectations and low corporate bond default
exposures. Insurers with executable cost-cutting
potential are also attractive.
Our top Overweight recommendations are Alleanza,
AXA and Munich Re. We recommend Euler
Hermes for investors with greater risk appetite.
We would avoid Underweight (V)-rated AEGON,
Hannover Re, Mediolanum, RSA and Standard Life
where the risk-reward continues to be unfavourable.
But, we note some of these names have significant
cost-cutting potential which may surprise although
more material capital adequacy and asset gearing
debates will dominate these stocks.
We have a detailed discussion of the investment
case for each insurer from page 81 onwards.

What’s changed?
We upgrade Paris Re to Overweight (V) from
Neutral (V). We downgrade Admiral to Neutral
(V) from Overweight (V) and RSA to
Underweight (V) from Neutral (V). We have also
revised most of our price targets – see Exhibit 5.
Note on valuation
methodology
Under HSBC’s equity research model, a stock
will be classified as volatile if its historical
volatility (past month's average of the daily 365-
day moving average volatilities) has exceeded
40%, if the stock has been listed for less than 12
months or if the analyst expects significant
volatility. We have chosen to classify our whole
universe as volatile, irrespective of historical
volatility, because:
􀀗 Our price targets are derived after applying a
company-specific discount to our 12M SOTP.
􀀗 Our SOTP uses capital and/or earnings
multiples to reflect our views about
sustainability of returns by business line.
􀀗 This means our approach relies on balance
sheet levels, which can be significantly
affected by equity market, bond spread and
bond yield movements.
􀀗 In volatile market conditions, as we are
currently experiencing, insurance balance
sheets, SOTP estimates and price targets are
likely to be volatile.
􀀗 This makes it difficult for our price targets to
remain within HSBC’s absolute rating bands

目录

Investment summary 1
Cost cutting calculator 8
Capital adequacy 33
Cash flow 57
Credit 61
Valuation 70
Valuation methodology 77
Company section 81
Admiral 82
AEGON 87
Alleanza 94
Allianz 99
Aviva 106
AXA 112
Banca Generali 119
CNP 123
Euler Hermes 130
Fondiaria-Sai 136
Friends Provident 141
Generali 146
Hannover Re 152
ING 157
Legal & General 165
Mediolanum 170
Munich Re 175
Paris Re 182
Prudential 187
RSA Insurance plc 192
Scor 196
Standard Life 202
Swiss Re 207
Zurich Financial Services 212
Disclosure appendix 220
Disclaimer 224