A European insurer growth profile - Generali

Life insurers' can have locked in growth
One of the good things about being in the life insurance business is that customers are with you a long time. The new business you write today should produce profits for years to come. Strange then, you might think, that you don't hear a lot of comment in the form of "they only reported Y of operating profit this year but the new business would produce a multiple of that - NxY, of profit per annum". Or, to be precise, to say that is what would happen if they simply wrote the same amount of new business every year.

Well, we believe its a fair challenge. And its an approach that would separate the genuine growth stories from the others. We've been looking at that multiple, 'N', and one example we'd like to highlight is Generali, where we calculate the multiple at 2.4x. Yes, 2.4x. That is a very, very, impressive level of locked-in life profit growth, and one of the highest in the sector.

How to identify the multiple
Its calculated from the new disclosure of 'undiscounted new business profit'. But is the result for Generali some kind of distortion from the peripheral Eurozone crisis? Seems not. Its around where we'd estimated it before and the plain fact is that, on the ground, Generali, along with one or two others in the sector, is not reporting IFRS operating profit derived from legacy business with no real counterpartt in new business. And its that sort of thing that, relative to Generali and one or two others at least, depresses the multiple for many insurers with large businesses in European or US life insurance.

It is somehow poetic that despite all the fancy 'embedded value' (or 'EV') reporting and the esoteric trills added to the score by the high priests of the art in recent years, this sort of simple measure is not made a lot more obvious in life insurers' reporting. We call 'N' the 'locked-in growth multiple' and we estimate it using the procedure described below, plus a few adjustments to keep things comparable between the different life insurers, allow for investment management profits in the EV reporting, whether the undiscounted new business profit does or does not include costs on day one and such like.

So what we're doing is estimating the multiple of current IFRS life operating profit that would arise from writing the most recently reported new business every year. And if you've got that you can miss the box out for now if you wish!


                             LIFE INSURANCE LOCKED-IN GROWTH MULTIPLE

                   

What it means for Generali is important because ...
The important point is that in Generali's case it should mean reported life operating profit has real momentum. Not necessarily quarter to quarter, or even year to year. But it will be on a robust trajectory to much higher levels over the medium term and it's not easily going to be knocked off course.

As a comparison the multiple for Standard Life is nowhere near Generali's 2.4x. We calculate it at just 1.4x, and that is using the lower starting point  for IFRS profit of £650mln suggested by Standard Life as the new run rate (rather than the reported circa £900mln). Recent Q1 new business sales numbers were bouyant for Standard Life but the key will be whether the new business is very profitable. We expect it is low margin, and probably, at least in the case of the auto enrollment sales that provided half the growth, very low margin. In other words, not much future profit.

Generali's Q1 results are on Friday 10 May. Non-life is recovering. The p/e multiple on consensus forecasts is just under 11x. Life profits are on a robust higher growth trajectory, in our view, and the company has been transforming how it communicates with stakeholders under new MD Mario Greco.

We think Generali should have a great story to tell, the Italian negative is not what it was, and the share price has been showing some intriguing signs of life recently. We shall see.

All comments welcome

Ed Outsure can be contacted at citizent@live.com

Standard Life, non-standard remuneration, LTIP target ambushed

Standard Life's 2012 Report and Accounts were published yesterday (April 2). For the first time the financial target that determines share grants to the three top executives under the LTIP (long term incentive plan) is purely a matter of the reported figure for IFRS operating profit exceeding a pre-set level. That level was set in 2010. At the same time, curiously, the remuneration report no longer includes a sentence in the 2011 Annual Report which stated, on page 69, that

"In reviewing the outturn of both our short-term and long-term plans the Remuneration committee considers the details of the results to ensure that the reported figures reflect the underlying performance of the business."

To be clear, this sentence is no longer included. It is not in the remuneration report in the 2012 Annual Report. If shareholders do not want LTIP pay to be boosted by short-term one-off profits, they must rely on a slightly weaker sentence which does appear in both the 2011 and 2012 report and which states that the LTIP scheme

"requires the remuneration committee to be satisfied that operating profit performance reflects overall Group performance".

It may be that the remuneration committee felt they were at risk in some sense, perhaps including legal risks, from the 'underlying performance' commitment in light of the new LTIP targets. However that would raise huge concerns in itself and, overall, it is in our view deeply problematic that the safeguard provided by the 2011 commitment on underlying performance has been dropped. It surely is a rare backward step in remuneration governance. Still, the 'reflects overall group performance' requirement probably would be strong enough - if the remuneration committee can be relied upon to apply it rigorously.

In this context the figures themselves tell quite a story. So lets look at them.

2012 performance

The remuneration committee approved the maximum share grants to the CEO, CFO and head of the investment operation, SLI, under the LTIP. In other words shares worth 200% of salary for the CEO, using the share price as at the date when the 2012 scheme was set in motion in 2010, become the CEO's in June 2013. A 'back of the envelope' calculation suggests that, in light of the rise in the share price since 2010, the value has now become circa 350% of salary or more and has been calculated at over £2.8mln. For the sake of completeness we should add the three executives also receive other bonuses in addition, which are of a not dissimilar order.

LTIP schemes are, in general, cast as demanding performance hurdles for senior management.

The actual payout for 2012 is the maximum possible under the plan because IFRS operating profits exceeded the target of £600mln for the maximum payout. For 2013 the relevant figure is £800mln (see pages 80,81 of the 2012 Annual report). The threshold for zero LTIP payments is £400mln for 2012 and £650mln for 2013.

Operating profit was £900mln in 2012, or £892mln excluding associates. The latter being the actual number the scheme uses. The remuneration report quotes this result and then says

"in line with the above results, the Remuneration Committee determined that 100% of awards granted in 2010 should vest in June 2013"

So the remuneration committee decided that the operating profit did indeed reflect "overall Group performance" then?

But, errr, the CFO says quite explicitly in the transcript of the analysts' meeting following the 2012 full year results that the operating profit did no such thing (see below)!

2012 always was going to be the senior executives' best chance to hit maximum LTIP payouts given the target hike to £800mln in 2013 from £600mln in 2012. And when the 2012 year came into view the LTIP target met with quite an ambush.

Lets Tamper with the Incidence of Profits

On page three of the transcript of the analysts' call after the 2012 full year results, CFO Jackie Hunt describes several one-off features of the 2012 operating profit.

These include a £96mln payout in 2012 from a professional indemnity insurance policy held by Standard Life. The policy eventually paid out, in 2012, to protect Standard Life from costs incurred in 2009 in reimbursing investors in a Standard life 'cash' fund which turned out to be invested in asset backed securities that suffered over the credit crunch. In Canada sales of real estate and other 'management actions' crystallized in 2012 profits that have been built up over many years. These actions added over £150mln to the reported 2012 Canadian profit, all of which was included in operating profit. Jackie Hunt, the CFO, said there still are some more of these profits to come but that in 2013 such profits would only run at half the 2012 level, and so half should be excluded from any assessment of the "run-rate ... of profit on a sustainable basis" for 2012, as Jackie Hunt put it. Similarly she said that £91mln, which arose from assumption changes should be excluded.

It is good that the CFO explained these items so clearly at the analysts' meeting. But a point we would like to add is that restructuring costs of £109mln are excluded from 2012 operating profit. Restructuring costs appear to be a regular feature. They were £70mln in 2011 and £71mln in 2010. In a big business like Standard Life this is completely reasonable. On a group wide basis restructuring is a never ending, quasi continuous, process.

Jackie Hunt said the run-rate of operating profit at end 2012, which she calculated by including half of the one-off investment profits in Canada and excluding all of the restructuring costs, was in the £640 to £650mln range.

another way of doing it is ...

You could do it differently of course, and get a lower answer for operating profit that would more credibly reflect "overall Group performance". For example excluding the one-off investment profits in Canada and deducting restructuring costs would mean an operating profit on a "sustainable basis" of around £475mln.

The three executives would, on this basis, only receive a fraction of the amount they are currently in line for.

In using £892mln the remuneration committee are, we suggest, taking an unnecessarily weak view of the "overall group performance" commitment to which they still are subject when assessing if LTIP targets are met; indeed they are giving it no effect at all. And in our view they clearly are relying on the absence in 2012 of the "underlying performance" commitment. If so, they certainly cannot argue that the change of wording does not matter. In any event, shareholders have not voted for one-off profits to trigger LTIP remuneration! Also, the wording change may make a big difference to LTIP payments for 2013.

And as for 2013

For what it is worth our analysis is that Standard Life's new business profitability does not currently support a sustainable IFRS profit of much above GBP550mln (after restructuring costs).

The analysis behind this is a separate piece of work which uses the "undiscounted new business profit". These are new numbers disclosed for the first time by Standard Life in their 2012 Annual Report and we use them, along with several adjustments, to assess  the medium term outlook for IFRS profit. We intend to elaborate the research in further posts. What we can say here though is that Standard Life's position is not enormously out of line (taking the suggested £640-650mln as a base level for reported profit). A wider comparison of undiscounted life new business profit with reported IFRS operating profit suggests one or two life insurers are in a worse position by this measure than Standard life. Equally there are two or three life insurers across the UK and Europe in a far better position and which we view as storing up an impressive growth outlook for IFRS profit through their new business profitability.

But the point is the analysis suggests it would be a big stretch for Standard Life to generate IFRS profit much above the threshold for zero LTIP payments in 2013, at least on a sustainable basis.

Is this right? Well here's a straw-in-the-wind - after becoming entitled to her wopper 2012 related LTIP payment CFO Jackie Hunt promptly upped sticks and left to join Prudential plc as CEO of UK and Europe - funny that!

All comments welcome.

Ed Outsure

Ed Outsure can be contacted at citizent@live.com