South Africa’s life insurers are trading at deep discounts. It’s a situation that poses opportunities for investors — but investment professionals are decidedly split about the sector.
It all started with a devastating virus. The pandemic saw life insurers cough up R1.13-trillion in claims and benefits during 2020 and 2021, according to the Association for Savings & Investment South Africa (Asisa). Despite the large payouts, the industry is still with us. And healthily capitalised at that.
Asisa surveyed life insurers earlier this year and said in September their assets, which they need to hold against possible claims, exceeded their liabilities at end-June by about R335.8bn.
Yet despite their healthy balance sheets, the four largest life insurers — Sanlam, Old Mutual, Momentum Metropolitan and Discovery — aren’t trading anywhere close to their historic valuations. Sanlam sits on a historic p:e of 12.5, Old Mutual on 5, Momentum Metropolitan on 5.8, and Discovery on 15.
One explanation for the cheap valuations is that they’re a function of broader sentiment towards South African financial service providers. The four largest traditional full-service lenders (Standard Bank, FirstRand, Absa and Nedbank) are also trading at low p:e multiples. Even on their price-to-book valuations, they look cheap.
“There is pressure on the whole South African financial market,” says Leonard Krüger, fund manager at M&G Investments. “The whole market is trading at low multiples. Investors are spoilt for choice.”
Also, the ease of understanding how a business makes its money may play a role when choosing among financial stocks. So the calculation of an insurer’s embedded value, which relies on assumptions about mortality, longevity, policy lapses and other variables, may deter investors.
Life insurers are complicated businesses and when the whole market is cheap, you don’t necessarily want to pick the complicated ones
— Leonard Krüger
“Life insurers are complicated businesses and when the whole market is cheap, you don’t necessarily want to pick the complicated ones,” Krüger says.
Bond yields have also weighed on life insurers.
These companies need to hold assets that match the value of calculated liabilities. These may include future payments of death and disability cover, as well as guaranteed annuities sold to pensioners that will continue to be paid until the pensioner dies.
To cover these future liabilities, the life insurers make assumptions on the future value of these benefits and discount them back to today’s value. This discounting considers both longer-dated bond yields and inflation.
“Long-dated bond yields are very high,” says Krüger. For example, the yield on 10-year South African government bonds stood at about 11.2% on October 27. “This makes the discount rate for future liabilities very high too.”
What’s more, most life insurers own short-term insurance units that were badly hit by claims following the flooding in KwaZulu-Natal earlier this year.
As the claims racked up, returns on life insurers’ investment portfolios disappointed amid the global sell-down in equity and bond markets.
“Because the markets are weak, the investment component of insurers delivered lower returns,” says Krüger.
That’s evident in the share price performance of the top four: Old Mutual, on a total return basis (including dividends) has fallen 13% year to date, along with Discovery. Sanlam is down 5% and Momentum shares have slipped 4.2%.
In the meantime, the Competition Commission’s investigation into life insurers hangs over the industry. The commission is investigating whether companies are colluding in setting prices for risk products, such as death and disability cover, as well as the way in which they price retirement annuities.
Notwithstanding this investigation, competition appears to be healthy, given the rise of sales in micro life insurance and especially funeral cover. This makes the sector less appetising for some investors.
“South Africa is an overinsured country and new entrants have made strong inroads into life insurance, creating chronic overcapacity,” says Roger Williams, MD and chief investment officer at Centaur Asset Management. “Traditional insurers have persisted in the same business model, resulting in them not covering [their] cost of capital and consequently [delivering] poor returns for shareholders.”
Like Krüger, Williams sees the complicated nature of insurers’ financial reporting as an issue.
Cash flow from life insurers has generally been well below reported earnings, in particular Discovery Life, and life assurers’ earnings are treated with circumspection by investors
— Roger Williams
“Cash flow from life insurers has generally been well below reported earnings, in particular Discovery Life, and life assurers’ earnings are treated with circumspection by investors,” he says.
Krüger owns shares in Old Mutual and Momentum Metropolitan, which have the most upside despite the uncertainties they face.
In Old Mutual’s case, he says the insurer is “particularly strong in the mass market” but is facing increased competition from the likes of FNB Insure, Capitec, Sanlam and Outsurance.
“People are quite concerned about this,” he says. “The icing on the cake is under threat.”
In Momentum Metropolitan’s case, Krüger uses the analogy of a supertanker slowly turning in the right direction. “They’re not quite getting the recognition for this,” he says.
But Williams is avoiding the sector. “Life insurers appear cheap relative to optimistic reported enterprise values but the industry is a classic value trap: appearing cheap on a static basis, yet on a dynamic basis delivering returns below its cost of capital.
“I am not a long-term investor in life assurance due to its challenged business model and poor outlook. However, if management changes course and embraces a value unlock this may change. The key drivers of South African life assurers are negative due to global risk aversion, and I am not a buyer currently.”
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