RGA - Reinsurance Group of America: Attractively Valued With Potential Life Expectancy Upside

2024-01-04 15:35:29 ET

Summary

• Reinsurance Group of America shares have risen 13.5% in 2023, but below the market's return.
• RGA is a noncyclical company that primarily reinsures against life and healthcare risk, making its results more stable.
• The company has seen stronger results in most units, with improving mortality and strong investment income driving revenue growth.

Shares of Reinsurance Group of America ( RGA ) have been a mixed performer over the past year, rising 13.5% in 2023, a reasonable return in a vacuum, but well below the market’s return. RGA is a relatively noncyclical company, which should see prolonged benefits from elevated rates this year. At less than 1.15x book value, I view shares as attractive with low double-digit return potential.

I have expressed caution about some reinsurers given my fear results in 2023 were unsustainably strong, given the light catastrophe year. Most reinsurers have meaningful exposure to property & casualty catastrophe, insuring against hurricanes, etc, which can make results volatile and storm-dependent year by year. RGA is an exception to this, as it primarily reinsures against life and healthcare risk. This tends to make results more stable than other reinsurers over time.

In the comp any’s third quarter reported in November, it e arned $5.57 in adjusted operating income per share from $3.92 last year. As you can see below, the company reported stronger results across most units. This is because RGA has been seeing improving mortality in the US while mortality was weaker in EMEA. RGA reinsures risk from life insurers, suffering losses when policyholders die more quickly than actuarily assumed. Excess mortality during the COVID pandemic led to weaker underwriting results, but with mortality returning to trend, we have seen improvement.

As a consequence, the company has earned a strong 14% return on equity over the past year, which is actually slightly above its 11-13% target, aided by strong investment results, which I will discuss further below. The US and Latin America account for the majority of the business, and premiums are up 6% here in 2023 while they have been down 1% in Canada, and flat in EMEA this year, with Asia another pocket of strength, up nearly 7%. Overall, traditional premiums are up 4.7% over the past year to $9.4 billion. Currency has been a 1.3% headwind, though with the Fed set to cut rates, we could see the US dollar weaken, reversing this in 2024.

Now, revenue was up 25% over the past year, far exceeding traditional premium growth. This included $820 million from one large pension risk transfer transaction. These transactions can be very lumpy, distorting the growth rate in quarters when a large transaction occurs. I view this business as quite complementary to RGA’s core business, though. As a life reinsurer, RGA “loses” when policyholders die sooner than expected. However, a pension benefits when its beneficiaries die more quickly. This line of business helps to hedge some of the mortality risk inherent in RGA’s business.

The other major driver of revenue growth has been investment income, which was up 20% to $922 million in Q3. Excluding variable investment returns, RGA’s yield rose to 4.51% from 4.12% last year. RGA has earned 6.31% on new dollars, helping to drive this increase.

Now with the Federal Reserve expected to cut rates in 2024, some may worry that this increase proves to be short-lived. While we have likely seen the bulk of the gains, I expect to see investment income remain elevated for some time. This is because RGA has a longer-dated investment portfolio, given it reinsures life risk, which can take years, or even decades to materialize. The company has long-dated liabilities with an average duration in US traditional of 11 years, Canada 14 years, EMEA 8 years, and APAC 15 years, and its investment portfolio is structured to match the duration of these liabilities.

Moreover, management has been extending maturities to lock in higher rates with just 8% of the portfolio floating-rate. As you can see below, the vast majority of its portfolio is in investment grade bonds. Of its ~$54 billion bond portfolio, nearly 2/3 is rated A or higher with just 6% below investment grade, leaving it with minimal credit risk.

In terms of riskier investments, RGA does own about $2 billion of collateralized loan obligations (CLOs), though they are investment grade and have proven durable in past downturns. More pressingly, it owns $7.3 billion in commercial mortgages. About $2.5 billion is in retail and $1.7 billion in office. Office faces well-known structural problems, but this exposure is suburban with a 60% loan-to-value, meaningful valuations would have to fall significantly for RGA to take losses. Maturities in this portfolio are well-laddered. I view this risk as one to monitor but likely to be manageable

Beyond solid operating results, RGA has a strong capital position. It carries just 14.6% debt to capital from 16.6% in 2021, and the company has $1.1 billion of excess capital. RGA has maintained a balanced capital allocation framework, balancing buybacks, dividends, and business growth. RGA has grown its dividend for 15 years with an 8.5% 5-year growth rate. It did $50 million of repurchases in Q3, leading to a 1.7% share count reduction over the past year. As you can see below, it has directed most capital back into the business, returning about a total 3-4% yield to shareholders each year.

This new business growth has pushed up reserves 8% over the past year to $36.5 billion. That is consistent with the company’s 8-10% targeted EPS growth over the medium term with an 11-13% return on equity. Recently, it has been able to write policies above that hurdle, aided in part by higher yields.

RGA should earn about $19.75-20 this year. In 2024, I expect results to be $19.25-$19.75, assuming some moderation in underwriting results while investment income remains near current levels. Over the longer-term with a ~12% ROE, I believe RGA merits a 1.2x book value multiple. With book value ex-AOCI at $143, that is a fair value of $170 today, and with normalized earnings growth in the upper-single digits, I would expect fair value to migrate up to $180 in a year.

One possible tailwind beyond this would be an improvement in life expectancy. We have seen GLP-1 drugs targeting diabetes and obesity show tremendous potential. If these or other innovations become more widespread, we could see mortality improve. A one-year change in life expectancy is worth about $2 billion in present value to RGA’s business, or about $30/share. This may or may not occur, but given the promise coming out of our pharmaceutical industry, risks seem skewed to life expectancy starting to rise again.

With about 10% return potential in a static environment, and a further 20% upside potential if drug developments continue to generate benefits, RGA is an attractive investment opportunity. With its unique exposure profile, I view it as the best positioned of the major reinsurance companies, and I view shares as a buy for long-term investors.

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