ZFSVF - Zurich: IFRS 17 Might Provide An Upside

2023-04-09 01:04:42 ET

Summary

• New regulatory requirements on IFRS 17 data might support insurance companies to be more understandable.
• At today's Annual General Meeting, Zurich confirmed its tasty dividend payment.
• Farmers division: from Achilles heel to an earning engine. Our Zurich buy is confirmed.

Today, we are back to comment on Zurich Insurance Group (ZURVY). Here at the Lab, we already reviewed a few European insurers, and as already mentioned in our Aegon N.V. ( AEG ) and AXA SA ([[AXAHY]], [[AXAHF]]) follow-up, looking at Mare Evidence Lab's EU insurance coverage, three companies have investments in the Credit Suisse AT1s. Unfortunately, Zurich is one of them, but we should mention that its exposure is only about $2 million. As a reminder, Aegon and Allianz have €3 million and €1 million in CS's AT1 bonds, respectively. Looking at Zurich's bond investments versus CS, we see limited investments in senior bonds for a total value of approximately €200 million (which are now " safer " thanks to the UBS-CS merger). In addition, at the aggregate level, Zurich's investment in bank AT1 bonds only stood at €30 million.

Right now, the Swiss insurer player is the safest company in our coverage thanks to a Solvency Ratio II that exceed 265%. This is well above the regulatory requirement imposed by the Swiss Financial Market Supervisory Authority FINMA which is set at a minimum of 160%. Given our 10-year analysis of Zurich's main financial ratio, we might assume that this Solvency Ratio is the highest result ever achieved by the company. This will definitely support our investment thesis called In Uncertain Times, Buy A Swiss Safe Haven and provide an additional margin of safety in case of corporate bond defaults.

New IFRS 17 regulation - a recap

With IFRS 17 introduction, insurers' net profit will become more volatile. Until the companies are not publishing their 2022 comparative data, there are no reliable estimates that can be used to evaluate them and after having checked the new regulation, some key performance indicators might be more volatile. An example is the combined ratio (the indicator that relates claims cost to premiums price). This ratio will include changes in interest rates on claims reserves. While IFRS 17 includes the present value of future long-term earnings and will provide a better intrinsic value, it also tends to increase the company's return on equity. To balance earnings volatility (linked to changes in non-life interest rates), insurers decided to increase their 2022 reserves. For instance, AXA is leveraging IFRS 17 introduction to streamline its 70+ pages of financial supplement to 12 pages. Here at the Lab, we believe that this data rationalization will force analysts to have more concise and perhaps even more consistent income models. This could help to make insurance companies more attractive over the medium-term horizon. As a reminder, the new accounting standard will not affect solvency, cash flows, or dividends, so the accounting change should not be material. However, our internal team believes that it will shift investors' attention toward the CSM, the Contractual Service Margin (representing the profit not yet earned from a group of contracts). This will be mandatory and will include future earnings estimated in the financial statements. This change mainly benefits life and non-life companies and provides support to Zurich's stock price development.

Aside from a supportive regulatory framework, we are still positive of Zurich for the following:

1. On a sector level, thanks to Mare Evidence Lab's calculation , we believe that insurance players have more than a 10% upside in a recession environment;
2. Last time, we emphasized how the Farmers division was very well positioned to deliver in an inflationary scenario with limited claims risks. We were also confident in the US MetLife's acquisition. Well, the Farmers division is now present in all the US with a nationwide presence and will be able to achieve significant economies of scale by consolidating the market (Fig 1). This division now significantly contributed to Zurich group earnings thanks also to its fee-based remuneration business (Fig 2) as well as its diversified product mix;
3. Today, after having participated in Zurich's Annual General Meeting, the company confirmed its dividend payment of CHF 24 per share. This confirmed our latest publication called Another Dividend Increase and the company's ability to increase shareholder's remuneration while investing for growth (and inorganic acquisitions). As a reminder, the Zurich dividend date is very close , the company is expecting to pay its DPS on April 14th. This represents a yield of almost 5.5% at today's price;
4. According to our internal estimates, Mare Evidence Lab's EPS growth was forecasted at a conservative rate. If we project the new strategic plan (supported by Zurich's track record), we should increase the company's valuation. Here at the Lab, aside from the supportive IFRS17 framework, we believe that the company will deliver a higher sustainable return on equity. Strong growth in cash remittance and a tasty dividend yield cannot go unnoticed and provide the necessary support on downside risks. Given Zurich's immaterial exposure toward Credit Suisse's riskier assets, we reiterated our valuation at CHF 475 per share.

Source: Zurich Investor Presentation - Fig 1

Fig 2

For further details see: