Prudential (LSE: PRU), Admiral (LSE: ADM) and Aviva (LSE: AV) all have attractive qualities as long-term investments, but volatile equity markets can be troublesome for these companies.
You see, insurance companies allocate a percentage of their invested assets to common stocks, which may boost long-term returns, but are also a source of capital volatility. Recent equity market declines and continuing instability raises questions regarding insurers’ capital strength, given their exposures to equity investments.
A lesson learned
Aviva’s management knows all too well how damaging market volatility can be to profitability and a company’s reputation. Back in 2011, the Eurozone crisis wiped out a third of Aviva’s capital cushion almost overnight and ever since, the company has been trying to improve its reputation. Falling bond values and equity prices wiped £700m and £400m, respectively, from the group’s £4bn capital buffer in the space of just 12 months back in 2011. But could this happen again?
Aviva’s current management doesn’t think so. The group was transformed after buying peer Friends Life, and as of August last year, Aviva’s capital surplus totalled £10.8bn, covering the company’s commitments by more than 170%. This figure implies that the group is well insulated from any sudden shocks. Aviva’s own analysts have stress-tested the company’s balance sheet and believe that, even after a 20% fall in equity values, the group’s economic capital coverage ratio will remain above 170%. So, it looks as if Aviva has learnt its lesson.
Well prepared
Admiral also seems to be well prepared to weather any storm in the equity markets. At the end of August, the group’s capital surplus was around 270%, after accounting for payment of 2015’s interim dividend. Admiral is able to report this advantageous capital position after issuing £200m of 10-year dated subordinated bonds in 2014. Without this extra capital, Admiral’s capital surplus would be around 100%.
Still, Admiral looks to be well capitalised for the time being, which is good news for the company’s shareholders. With a robust capital position, City analysts expect the company’s shares to support a dividend yield of 5.9% per annum for the next few years.
Yesterday Prudential became the first UK insurer to announce its capital strength under the new Solvency II rule. Its capital solvency ratio, a measure of the amount of capital it has as a proportion of the minimum required, came in at 190%. The figure was at the top end of analysts’ expectations of 180% to 190%, although lower than the 218% that the insurer reported for 2014. Nonetheless, for an insurance giant such as Prudential, a Solvency II ratio of just under 200% signals that the group is unlikely to run into trouble anytime soon.
Overall, it looks as if Aviva, Admiral and Prudential are all well positioned to weather the recent equity market volatility.
What’s more, with such hefty capital buffers in place, the dividends of these insurers look to be safe for the time being. At time of writing Aviva’s shares support a dividend yield of 4.1%, Prudential’s shares support a yield of 2.7%, and as mentioned above, Admiral is set to yield 5.9% this year.