Funds in focus:
Brompton Lifeco Split Corp. (LCS, LCS.PR.A);
Life & Banc Split Corp. (LBS, LBS.PR.A);
Brompton North American Financials Dividend ETF (BFIN)
Canadian life insurance companies (“lifecos”) have significant exposure to various macroeconomic factors including interest rates, equity markets, and corporate credit. Interest rates typically have the biggest impact on the sector as lifeco reserves and earnings have historically had a high degree of economic sensitivity to changes in interest rates. This is the result of a duration mismatch between a lifeco’s insurance liabilities and its invested assets. Most life insurance products result in a long duration liability for the company that writes the policy. This occurs since buyers of life insurance policies are often in their early 40s and therefore expected to live for several decades. A lifeco’s invested assets, on the other hand, typically have a shorter duration profile. This mismatch means that lifecos are generally helped by rising interest rates and hurt by declining interest rates.
Over the past decade, however, the Canadian lifecos have taken significant steps to reduce the impact caused by low interest rates, while still maintaining some upside exposure to higher rates. The biggest factors contributing to this are as follows:
- shift in business mix to focus on products with less interest rate sensitivity:
- re-pricing of insurance products to account for low interest rates when determining the customer premiums:
- better management of the asset and liability mismatch through the investment portfolio and hedging activities; and
- focus on cost cutting and operating efficiency.
As a result of these measures, the life insurance sector has been able to generate higher and more consistent returns over the past several years. Exhibit 1 shows the median quarterly return on equity (ROE) for the Canadian lifecos from 2009 to present. For the period from 2009 to 2012 the median ROE averaged 7.0%, while this improved to 12.2% for the period from 2013 to 2023 and is expected to rise to 14.7% in 2024 according to Bloomberg consensus forecasts.
Exhibit 1 – Better Earnings Quality Through Consistently Higher ROEs
Source: Bloomberg as of January 4, 2024
Additionally, while some of these factors, such as a shift in business mix and better balance sheet management, also reduce the benefits of higher interest rates, other factors, such as product re-pricing and operating efficiency, mean that the lifecos stand to benefit significantly from the rise in rates we have seen over the past two years as new premiums are invested into higher yielding assets. While there may be some movement lower in interest rates over the coming quarters as inflation continues to subside, we believe that we are in a “higher for longer” interest rate environment and that we are unlikely to see rates move back towards zero like we did in the decade after the global financial crisis. As such, we believe that returns for the lifecos in the coming years are likely to remain elevated relative to the experience of the 2010s.In our view, higher and more stable returns demonstrate that Canadian lifecos have been producing better quality earnings over the past several years than they did a decade ago. We believe that this should have translated into an improvement in valuations. However, Exhibit 2 shows that the Canadian lifecos currently trade at only 9.0x forward P/E, which is well below the long-term average of 10.2x.
Exhibit 2 – Valuation Multiples Look Attractive
Source: Bloomberg, as of January 4, 2024
Given the improvement in earnings quality and the expectation for higher ROEs in 2024, we believe that there is upside potential in valuations and that the lifecos present an excellent buying opportunity at this time.
Brompton’s Approach
At Brompton, we have decades of experience investing in Financials and have several products that investors
can use to get exposure to the Canadian lifecos, including in our split share funds and ETFs. The following
Brompton funds all trade on the TSX and focus specifically on Financials including an allocation to lifecos:
Brompton Lifeco Split Corp. (LCS), Life & Banc Split Corp. (LBS), and Brompton North American Financials Dividend ETF (BFIN; BFIN.U).
Brompton Lifeco Split Corp. (LCS) provides leveraged exposure to Canada’s four largest lifecos and high
monthly distributions:
