We upgrade Prudential to Overweight
(V) from Neutral (V); and Standard Life
to Neutral (V) from Underweight (V)
􀀗 We retain Legal & General at
Overweight (V), Aviva at Underweight
(V) and Friends Provident at Neutral (V)
􀀗 We advise against unhedged positions
in the UK life sector unless investors
have a positive financial market and
macroeconomic outlook
Solvency: Regulatory capital buffers, the ultimate pressure
point for forced capital raisings, have been eroded but
remain fairly strong particularly after considering additional
levers available to management.
Dividends: Legal & General (L&G), Prudential and
Standard Life’s dividends are well covered by operating cash
flows; while Aviva and Friends Provident’s (FP) dividends
are most likely to disappoint if financial markets do not
improve significantly.
Asset leverage remains high – Prudential has the highest,
Friends Provident the lowest. Corporate bond and ABS
remain the main source of concern but insurers are not
forced sellers so it is defaults rather than mark to market
movements that matter. We continue to assume 22% for
below investment grade defaults (no recoveries) and 0.82%
for investment grade in our 2009 earnings estimates. That
said, stocks fell sharply on the back of rising corporate bond
spreads, so should rise as corporate bond spreads fall.
Valuation: We find it difficult to compare stocks in our
coverage universe on a truly consistent basis given
significant differences in reporting bases. Embedded value’s
status as a comparable valuation metric has been further
damaged by ‘illiquidity premia’ in CFO Forum embedded
values, PEs are difficult to compare given UK companies’
poor IFRS disclosure (L&G and Standard Life in particular)
and tangible net asset value has been a significant driver of
share prices but it has been mis-used as returns were ignored
initially. We look at an array of valuation metrics as a result.
Our target prices have been revised in this report.