IAG Flush With Cash for Market Downturn: Corporate Canada

Industrial Alliance Insurance and Financial Services Inc. is poised to continue outperforming Canadian insurance peers as it shores up capital to guard against a decline in stocks.

IAG, as the insurer is known, gained 16 percent this year after raising its capital ratio to a level higher than competitors including Manulife Financial Corp., the largest Canadian life insurer by market value. The increased capital safeguards IAG, whose earnings are more sensitive to interest rates and stock prices than peers because they rely more on long-term products.

“It’s a cushion against any worst-case scenario,” Mario Mendonca, an analyst at Canaccord Genuity Inc. in Toronto, said in a phone interview May 7. “As an insurer, their earnings’ sensitivity to economic factors is still high, except now they have this trove of equity to fall back on.”

Quebec City-based IAG, the smallest Canadian insurer, issued C$237.4 million ($235.7 million) in common shares in February, raising its so-called continuing capital and surplus requirements ratio to 237 percent. Toronto-based Manulife, Canada’s largest insurer and owner of Boston-based John Hancock Financial, has a capital surplus ratio of 217 percent. Sun Life Financial Inc., the No. 3 insurer, is at 214 percent for the first quarter of 2013.

The government requires insurers carry a surplus ratio of 150 percent. When equities decline and interest rates are depressed, insurers’ liabilities can increase on contracts in which they guarantee minimum returns.

Earnings Release

Alliance reported profit of 85 cents a share, beating the 79 cents average estimate of 11 analysts in a Bloomberg survey, and an increase from 69 cents a share in the year earlier period. Net earnings and deposits rose to a record.

“Our first quarter performance was solid on all metrics,” Alliance Chief Executive Officer Yvon Charest said in an earnings release today. “Our solvency ratio remains extremely strong and our leverage ratio shows meaningful improvement as a result of our recent capital strategy.”

IAG is Canaccord’s preferred life insurance stock and Mendonca rates it a hold.

IAG’s record-high ratio “improves the likelihood of viability in a difficult environment,” said Ian Cooke, fund manager at QV Investors Inc., which runs C$7 billion for Sentry Select Capital Corp. including IAG shares. “It provides comfort for regulators, customers, and for investors.”

Share Sale

The insurer’s sale of 6.3 million shares that closed on Feb. 27 led Standard & Poor’s to revise the outlook on its A+ rating to stable from negative. Manulife is rated A- and Sun Life is at A.

“Management has taken a number of proactive steps to strengthen its capital position,” S&P credit analyst David Zuber said in a Feb. 20 note.

“Insurance has been a tough space to be in for a number of years,” QV’s Cooke said in a phone interview from Calgary. “The low interest-rate environment has hampered profitability and challenged businesses.”

IAG, which has a market value of about C$3.55 billion, fell 2.5 percent to C$36.27 in Toronto, the most since February. The shares have climbed 16 percent this year, compared with 15 percent for Manulife and 11 percent for Sun Life. Great-West Lifeco Inc., the second-biggest insurer, jumped 15 percent.

Over the past five years, IAG has returned 18 percent, including dividends, compared with declines of 19 percent for Sun Life and 50 percent for Manulife. The average target price for IAG for the next year as forecast by 11 analysts is C$38.91, or 7.3 percent higher than yesterday. Four analysts rate the company a buy while seven say hold, with one sell.

Greatest Risk

“IAG has had a couple of quarters now of earnings improvement and we see that trend continuing,” said Bruce Campbell, portfolio manager at Stone Castle Investment Management Inc., which oversees C$100 million including IAG stock. “We’re seeing improvement in equity markets and that improvement tends to lead to more sales in higher margin products for Industrial Alliance.”

To be sure, the company is the most exposed to interest rate changes among its competitors. A larger portion of IAG’s sales is made up of so-called universal life products, according to Peter Routledge, an analyst at National Bank Financial in Toronto. The company manages these long-term investment products, opening the risk that the company’s assumption of interest rates will be wrong, Routledge said.

The Canadian benchmark overnight rate, which has been 1 percent since September 2010, won’t rise until the third quarter of 2014, according to a forecast of 18 economists by Bloomberg News. In the U.S., the rate isn’t expected to rise until after 2014, a Bloomberg survey of 61 economists shows.

“The path of long-term interest rates poses the greatest risk” to Canadian insurers, Routledge said in an April 18 note to clients. IAG is the most at risk in a continued low rate environment which will persist “for an extended period,” he said.

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