Compare and contrast

I have always been leery of life insurers, and have always preferred P&C companies. A traditional P&C company does not have liquidity issues. Of course if there is a massive CAT, then the company has to pay claims, but if there is a ratings downgrade, customers may opt to not renew their policy but they cannot claim collateral, or demand payment etc... I like that. I went to a Fitch seminar a long time ago, and one sentence stuck in my mind: P&C companies fail because of problems on the liability side (under-reserving, adverse development) and a life company fails because of problems on the asset side (poor investment choices). This is because life companies liabilities are much longer in duration, leading to much higher asset to equity ratios. Realized impairments are therefore magnified on the equity line.
All of this was before the new guarantees on variable annuities, which have added a further layer of complexity to analysing these companies. Life companies also stretch for spread with GIC products, fixed annuity products and funding agreements. These products can not only lead to asset-liability mismatches but also push the insurer to stretch for yield. Hence more private placement debt, whole loan mortgages, CMBS, high yield, alternatives etc...
Bearing all that in mind, let's take a look at HIG. HIG stock has cratered. Why? first because the company has suffered massive realized and unrealized losses from its investment portfolio. The company has $15B of CMBS exposure and an overweight on the corporate side to financials. It also owned equities in financials (RBS and Barclays to name a couple) that are not coming back fast. WE are talking about $5.1b of realized capital losses in the first 9 months. With all this the company was buying back stock through the first half of the year, but then the second shoe dropped. As equity markets fell, guarantees on variable annuities went in the money, and not only does HIG suffer from lower fee income, but WORST, statutory capital requirements increase dramatically as this obligation needs to be covered. The company estimated that it would need an additional $2.5B of capital if equity markets were to hit 800 (30% down from Q3). This number would rise exponentially beyond that. So no surprise that it raised capital from Allianz. No surprise that the stock is trading at 0.25x BVPS, as no-one including management knows how much capital they need. Additional impairments are possible in the investment portfolio, rating agencies are getting nervous (downgrades would impair the institutional business first), and equity markets could drive capital needs even higher.
By the way, company always said the the risk in the variable annuities was hedged - apparently not enough! so what do you have now, a stock with a beta of 3. LNC and other annuity writers are also at risk. THAT is why, I never liked these guys. AND HIG and others will need to take large DAC write downs (basically the profitability of the business is less than they thought). Disturbing to me, is the explicit assumption of 8-9% market return built into these VA products by life companies. We have the S&P flat past 10 years.

Now let's turn to ACE. I just read the Q, and I like it. The one risk is 8.7B of corporate fixed income securities. There could be losses there in a big downturn, but manageable. ACE actually reinsures some variable annuity contracts but only GMDB and GMIB contracts. Risks are manageable (Max loss on GMIB at present is $539M, but nothing before 2013), and the company has stopped writing the business to keep within preset limits. As I said above, it is the liability side that gets P&C companies in trouble. ACE is releasing reserves, and has been more conservative than others. To be honest I have not done a reserve study recently, given the recent hard marke, but ACE is the only Bermuda to offer global loss triangles. ACE has asbestos exposure (was a big deal in 2002) but that is dormant right now. ACE is also very well positioned to take advantage of turmoil at AIG, XL and others. Result a stock trading above BVPS, and outperforming on big down days. This is my favorite stock in the balance sheet risk category (MA is my pick for income statement risk, and AOC is my most defensive name). Another good one would be CB.