Reinsurance Group of America (NYSE: RGA)

Reinsurance Group of America (RGA) provides life and health reinsurance.  The company has a global presence with operations in the United States, Latin America, Canada, Europe, Africa, Asia, and Australia.  The consistency of RGA’s earnings made us want to take a closer look at the company.  RGA’s conservative underwriting practices are evidenced by the company reporting positive net income and free cash flow for decades now.  We think a company with this kind of reliable performance deserves to trade at a premium to its peers.  Instead RGA trades at a discount to its competitors and an even greater discount to the market as a whole.  The company currently has a PE ratio of 13.61 compared to 18.48 for its sector.  Most other basic metrics show a similar discount for RGA compared to the sector.

	RGA	Sector
PE	13.61	18.48
Price to Sales	0.72	6.15
Price to Book	1.08	2.75
Price to Cash Flow	11.97	19.4

Source: Reuters

The discount to the sector above exists despite performance metrics in line with the sector as a whole.  Return on equity and profit margin come in at a respectable 19.8% and 13.7% respectively.  The company also appears to have plenty of room to grow its dividend given the very low payout ratio of 7.4%.  Of course, there are some reasons for this discount such as the low interest rate environment which is acting as a drag on the profitability of insurance companies and other financial institutions.  Another key risk is that growth has slowed in recent years with the main exception and growth opportunity coming from Asia where market access is often limited for foreign companies.

The Business

The company has made great progress diversifying its operations over the years. Originally it was a company focused on mortality reinsurance with revenue derived in U.S. and Canada.  Now, 9% of revenue comes from Canada, 14% from Europe, the Middle East and Africa, 19% from the Asia Pacific, and the remaining 58% coming from the U.S. and Latin America.  Mortality reinsurance now accounts for 68% of revenue compared to 100% in 1992.  22% of product revenue is from morbidity reinsurance with the remaining 10% from the Global Financial Solutions segment which helps businesses find solutions to improve capital efficiency and promote stability and growth. 

Morbidity has to do with the frequency a disease appears in a population while mortality has to do with the frequency of death in a given population.  Therefore, both types of reinsurance are associated with life insurance as well as health and long term care insurance.

Only two companies had higher global life and health reinsurance revenue in 2017 compared to RGA.  The top two revenue earners in this concentrated industry were Swiss Reinsurance Company and Munich RE.  Eighty percent of the global market is held by only five companies as a result of high barriers of entry such as the capital requirements.

Dependability & Growth Opportunities

Another way to consider the consistent performance of RGA is to consider the growth in book value.  Book value per share has increased with a CAGR of 12.3% and 14% for the last 15 and 5 year time periods, respectively.  While the shares have returned -6% for the year, RGA has outperformed the S&P 500 over the last five and 10 year time periods.  We think this outperformance will continue given its current low valuation and growth opportunities.  RGA cites a report from The Geneva Association which finds that about 4 billion people are uninsured globally.  The research organization, LIMRA, estimates the underinsured U.S. market to be worth $12 trillion and expects this number to grow by about $300 billion per year.  RGA sees wealth creation in emerging markets driving demand for life insurance.  Its international markets are where RGA forecasts the highest growth rates.  For example, the company predicts an operating income CAGR of 10 to 15% for its Asia region compared to the more modest 4 to 6% growth for the U.S. and Latin America region.  Medical and health advances will improve mortality rates.  RGA will benefit from macro trends with an aging population increasing the need for morbidity products.

The company has a conservative asset allocation with an average credit rating of single-A.  About 34% of the portfolio is rated AAA to AA.  92.8% of investments are investment grade with the biggest percentage, 46.7%, invested in corporate bonds and bank loans.  Only 4.1% is allocated to high-yield debt.

RGA provided adjusted operating EPS growth guidance of five to eight percent CAGR going out to 2020.  They maintain this is achievable via organic growth, transactional opportunities and effective capital management.  They list higher interest rates and the growth of international businesses as two of the key growth drivers.  Another key part of the guidance is annual operating ROE of 10 to 12%. 

The 2018 Insurance Industry Outlook report from Deloitte notes several opportunities for life and annuity insurers in addition to the benefits of rising interest rates.  The report notes that life insurance penetration for U.S. households stands at a record low of 30%.  This is despite 5 million more households having life insurance in 2016 compared to 2010 since this increase was largely due to population growth rather than higher market penetration.  Group life sales now account for a greater percentage of total life insurance sales than the individual market.  This may come as no surprise given that many large employers provide this benefit to employees.  This offers the benefit of guaranteed issue and little to no direct contact with the insured. 

The report also highlights the need for insurers to embrace digital technology across their organization.  Leveraging technology in industries outside of technology is a key driver of efficiency, increasing sales, and reducing costs.  In the case of insurers, digitization on underwriting allows for online distribution allowing companies to reach more potential customers, especially the younger demographic.  Making it easier for consumers to purchase life insurance could drive sales.  If a policy can be purchased online within minutes it will represent a big leap from the standard much more lengthy way of gaining life insurance coverage.  Of course, RGA would benefit with any growth in life insurance penetration due to the resulting increase in demand for reinsurance.

Valuation

We will take a look at RGA’s valuation by performing a discounted cash flow analysis.  The model will consider a 5 year time frame and use the EPS from the trailing twelve months of $10.83 which is substantially lower than the EPS estimate for next year of $13.39.  The average analyst estimate for the EPS annual growth rate for the next five years is 9% per finviz.  The actual EPS growth rate over the last five years was 7.1%.  Out model assumes that the growth rate will be somewhere between the two numbers and that RGA can achieve an 8% growth rate on average for the next five years. 

The real boost for RGA is likely to come from dividend increases.  The current dividend of $2.4 equates to a yield of 1.65% and comes with a very low payout ratio of 7.4%.  During the past five years the average growth rate in dividends per share was 14.8% per year.  The model will assume that RGA will grow its dividend by an annual average of 13% per year.  The model will use a future PE of 15 which is above its current PE of 13.61 but well below the sector average of 18.48 and well below the S&P 500 PE which comes in at a lofty 25.  Using these inputs along with a 10% discount rate indicates that RGA is trading at a 10% discount to fair value.  Given the cash flow reliability and potential for significant dividend increases, we think the DCF model warrants considering the company as a potential investment.  The model is conservative in several aspects.  For instance we assumed a dividend growth rate of 13% for year while the dividend was actually increased by 16.5% over the last 12 months.

RGA is also cheap relative to peers as highlighted previously.  It’s hard to find perfect peers for purposes of comparison since RGA is one of the few pure reinsurance companies with a focus on life insurance.  However, let’s consider Arch Capital Group (ACGL) and Everest RE (RE).  First of all, of the three, RGA is the only one with an attractive return on equity which was 19.8% for the trailing twelve months.  Everest’s return on equity came in at a meager 2.5% while ACGL had an ROE of 6.5%.  RE has also had negative net income twice in the last ten years in 2011 and 2008.  ACGL and RE have PE ratios of 23.21 and 47.65, respectively compared to RGA’s PE of 13.61.  While there are all kinds of growth estimates for the three companies let’s just consider the actual annual average EPS growth for the last five years.  RGA comes out ahead on this metric as well with 7.1% compared to trailing five year annual EPS growth averages of -6% and 0.90% for RE and ACGL, respectively.  The sector’s PE ratio is well above RGA’s coming in at 18.48.  The relative discount will be evident by looking at almost any over valuation metric such as price to sales or price to book.  RGA currently trades only slightly above book value.

Final Thoughts

In the midst of all time highs for the stock market, RGA is a company with the reliable in earnings trading only slightly above book value.  We see RGA as offering an attractive opportunity in terms of the current risk-reward relationship.  The company has had positive net income and free cash flow in each of last 10 years, is undervalued, and has the potential to surprise based on the relatively pessimistic outlook for the industry. This is a company that would likely benefit from higher interest rate and is one of the few stocks that has not already reached or exceeded fair value in the recent market run up.  We see the stock moving higher due to the company benefiting from interest rates as gradual (as they may be) and meeting or exceeding its growth targets with the current valuation greatly limiting any downside risk.