Industry Trends A Worry For AMP

This story features AMP LIMITED. For more info SHARE ANALYSIS: AMP

– AMP profit 12% below forecasts
– Wealth protection big loser
– Structural trends underlie
– Analysts remain cautious

By Greg Peel

Wealth manager and insurer AMP’s ((AMP)) share price had been rising steadily since mid-last year before peaking in May. The peak coincided with the sharp Fed/China-related plunge in the Australian stock market, highlighting the market’s perception that if the stock market is rising, AMP’s funds under management performance must also be rising, offering growth on a solid yield.

The share price pullback in June confirms this perception, with AMP punished along with just about every other Australian stock. Yet as investors continued to buy AMP shares in May, they didn’t know what was going on behind the scenes in AMP’s other sizeable business, life insurance, and specifically wealth protection (WP). There was no need for investors to be concerned given an upbeat assessment from management on the WP division at the company’s AGM on May 9.

Yesterday management downgraded its FY13 profit forecast by what amounted to a 12% reduction from consensus forecasts. The downgrade was mostly driven by $32m of life “experience” losses in WP over the five months to May, with the business now expected to provide a $54m first half 2013 profit when analyst consensus was sitting around $100m. The downgrade came as a shock, and unsurprisingly analysts have rushed to cut their earnings forecasts for both 2013 and 2014 and slash share price targets.

The shock element related mostly to the seemingly sudden deterioration in May in WP, given management was upbeat at the beginning of May, and less to the problems actually driving the losses. Has management really got a handle on what’s going on? The $32m loss breaks down into, adjusting for costs, $26m in claims and $8m in lapses, with half the claims stemming from income protection and the other half from deaths.

The first thing every broker noticed immediately was that a surprisingly large number of policy holders died in May. Anyone would think there’d been an epidemic. Analysts are at a loss to explain this spike, but all assume it’s just that – a statistical spike – and that the numbers will normalise ahead. But it is income protection claims and policy lapses causing concern. Recent commentary from National Australia Bank noted a heavy rise in disability claims over the past quarter, CIMB points out, and further anecdotal evidence suggests rising disability claims and lapses have become and industry-wide issue.

FNArena has observed ubiquitous funeral insurance ads on television now seem to have given way to a proliferation of income protection insurance ads, from everyone from AAMI to Virgin. The market appears to have become very competitive. Why else let a particular life insurance policy lapse?

“The underlying causes of [experience losses] are structural, industry wide and not easily fixed,” suggests Macquarie. The structural issues in the Life sector the industry is trying to address include product design, especially around mental health in income protection, lapse rates, particularly with regard to upfront commission structures for insurance planners, claims management and the increased propensity of policy holders to claim, and pricing structures which see some premiums increase as policyholders age. Goldman Sachs suggests the market has already been well aware of the lapse and disability claim issues facing the industry, and Deutsche Bank is not alone in assuming higher disability claims and rising lapse rates will potentially be recurring.

Cyclical pressures are likely to remain a headwind near-term, says Deutsche, given unemployment is expected to drift higher by year-end. The broker estimates every 1% increase in unemployment increases disability claims by $45m.

That seems strange. Why does unemployment lift disability claims? Perhaps the answer lies in AMP’s intentions to lift claims management, including fraud capabilities. AMP also plans to restore profitability through early intervention strategies and return-to-work initiatives, but Deutsche notes progress will be slow. Perhaps the most fundamental issue to address is summed up by UBS, with the broker noting “an industry approach to advisor remuneration structures is back on the cards again”. UBS suggests ACCC approval could take well over a year, nevertheless, and in the meantime economic pressures aren’t easing.

Have we seen this movie before? I seem to recall it was a decade ago when a backlash against fees and planner kick-backs led to a great migration away from the traditional wealth managers, of which AMP is one. What next, self-managed life insurance?

AMP’s other plan of attack to restore profitability is simple – just raise premiums. Analysts agree there is scope to do so given the problem of rising claims is industry wide and not specific to one insurer. Yet analysts also warn that to raise premiums at a time of economic weakness is to tread a very fine line, with a risk of increasing lapse rates beyond their current levels. Can the industry raise premiums in unison?

“We’d feel more comfortable with AMP at current levels,” says UBS, “if the roadmap to a restructured life industry was clearer to understand”.

Outside of the FNArena database, Morgan Stanley retains an Overweight rating on AMP, believing patience is merely required as the company turns the ship around. MS suggests there will be no recession in Australia and that we are at the early stages of an equity market recovery. The market has overreacted to the life insurance risks and adverse “experience” has likely peaked, the analysts suggest, while AMP can happily operate on a lower cost model.

Morgan Stanley engenders little support from its FNArena database peers. JP Morgan is arguably leaning to the positive side, but retains Neutral nevertheless, joining all but one other broker on an equivalent rating. Both Deutsche Bank and BA-Merrill Lynch have downgraded to Hold or equivalent ratings post the profit warning, with Merrills fearing a worsening economic backdrop and Deutsche believing uncertainty over industry pressures will likely keep investors on the sidelines. Macquarie agrees the negative experience from the WP business will continue, but on yesterday’s 13% share price fall has actually upgraded to Hold from Sell (Neutral from Underperform), while UBS wants to wait to hear more at the first half result and is sticking with its Sell rating at this time.

Following substantial forecast adjustments, the consensus target in the database drops to $4.75 from $5.37. Given AMP works on a payout ratio of 70-80% of underlying profit, Citi is among those cutting dividend expectations. Consensus yield forecasts show 5.4% for 2013, rising to 6.0% in 2014, but earnings growth is expected to fall next year.

Many Australians hold AMP shares given many Australians were policyholders at the time of demutualisation. Listed wealth manager/insurers always have a fundamental issue to deal with, being a conflict of interest between who should benefit most from the business, the policyholders or the shareholders? One offsets the other.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms