Focus on value added and validity of assumptions. Traditional valuation tools for lifecos do not reflect value added well

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1 Canadian Institute of Actuaries L Institut canadien des actuaires Vancouver

2 Desjardins Lifeco valuations Focus on value added and validity of assumptions The Desjardins Takeaway Michael Goldberg, CFA Financial Services (416) Traditional valuation tools for lifecos do not reflect value added well We find that valuations range from yield support/dividend growth to NAVtype value Two key drivers to watch are value of new business and experience gains/losses 2 Rising VNB is main basis for our targets and 11 19% forecast capital appreciation

3 Desjardins Lifecos traditional valuations Comparative valuation: North American Lifecos Actual EPS ($) Desjardins EPS ($) Consensus EPS ($) Earnings growth Shares O/S Mkt cap 07E/06A Book Div yld Canadian lifecos Price ($) 52-wk range ($) (m) ($m) Div/sh ($) 2006A 2007E 2008E 2007E 2008E (%) 08E/07A (%) 2006A 2007E 2008E value/sh (C$) P/B(x) (%) Great West Lifeco , % 12.5% 16.5x 14.4x 12.8x x 2.96% Industrial Alliance , % 11.9% 14.4x 13.4x 12.0x x 1.82% Manulife , % 14.3% 15.7x 14.1x 12.3x x 2.23% Sun Life , % 13.9% 13.7x 12.6x 11.1x x 2.56% Weigthed Average: Cdn lifecos 10.7% 14.0% 15.2x 13.7x 12.0x 2.2x 2.37% US comparables Aflac , % 14.3% 18.5x 16.0x 14.0x x 1.56% Lincoln National , % 12.6% 13.8x 13.0x 11.5x x 2.22% Metlife , % 8.7% 12.5x 11.9x 11.0x x 0.91% Principal Financial Group , % 13.2% 16.5x 15.1x 13.4x x 1.37% Prudential Financial , % 12.7% 16.3x 14.0x 12.4x x 0.95% Torchmark , % 8.6% 13.7x 12.7x 11.7x x 0.76% UnumProvident , % 14.2% 14.4x 13.6x 11.9x x 1.14% Weighted Average: US lifecos 10.2% 11.7% 15.0x 13.6x 12.2x 1.9x 1.22% P/E(x) 3

4 Desjardins Valuation: Lifecos vs banks Banks and Lifecos': Comparative Valuation Banks Lifecos' 2007 EPS growth 11% 11% 2008 EPS growth 8% 14% PE on 2007 EPS 13.2x 13.6x PE on 2008 EPS 12.1x 12.0x PB 2.8x 2.2x Yield 3.35% 2.38% Dividend Payout % 32% Dividend Payout % 28% 4 Similar P/Es for faster earnings growth in 2008 Lower price/book lower ROEs Lower yield, but also lower payouts

5 Desjardins Problems with traditional valuations: P/E Earnings do not reflect value added because of longterm nature of lifeco products Earnings mainly reflect income emerging from inforce business mainly release of PAD based on pricing assumptions Patterns of earnings emergence from different types of business can vary significantly Value added from new business is deferred Experience gains (losses) validate (or not) assumptions Persisting gains or losses can trigger assumption changes that have a magnified impact on earnings 5

6 Desjardins Problems with traditional valuations: P/B Not apples to apples PAD as unearned income the gray zone between liability and equity PAR surplus not included even though shareholders effectively have free use of these funds in perpetuity Differences between CGAAP and US GAAP 6

7 Desjardins These differences reduce the usefulness of earnings and book value what does that leave us with? 1. Dividend yield 2. Net asset value 7

8 Desjardins 1. Dividend yield As with banks, dividend growth signals companies confidence in sustainability of earning power Growth + Yield = Total Return Market rewards faster growth with lower relative yield and penalizes slower growth with higher relative yield 8

9 Desjardins Year-over-year dividend growth $1.40 $1.20 $1.00 $0.80 $0.60 $0.40 $0.20 $ Lifeco Annualized Dividends GWO ~ 20% growth for more than 10 years; has slowed to mid-teens -Most recent growth: GWO 14%, IAG 28%, MFC 26%, SLF 16% -Lifecos 21%, banks 18% 05 GWO IAG MFC SLF % 50% 40% 30% 20% All but GWO started dividends at zero YEAR OVER YEAR DIVIDEND GROWTH 60% 50% 40% 30% 20% 9 Dividend growth is where you really see the impact of compounding 10% 10% 0% 0% GWO MFC SLF IAG

10 Desjardins Dividend payout on adjusted TTM EPS 60% 50% 40% 30% 20% 10% 0% GWO IAG MFC SLF 10 GWO has risen from 40% to 45 50% IAG, MFC, SLF payouts trending higher IAG payout still the lowest payout objective 20 30%, reaching 28% by mid-2008

11 Desjardins P/E on adjusted TTM EPS IAG MFC SLF GWO 11 P/Es fairly uniform since 2003 With higher ROEs, GWO and MFC sell at premium P/Es Difficulty in justifying P/E-based valuations

12 Desjardins Lifeco relative yields 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% INTEREST EQUIVALENT DIVIDEND YIELD AS % OF LONG CORPORATE BOND YIELD monthly to May 2007 last data June 15, % 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% GWO IAG MFC SLF 12 Like banks, lifeco relative yields affected by expected dividend growth and flow of funds Faster dividend growth rewarded with low relative yield; slower dividend growth punished with higher relative yield GWO highest because of high payout; IAG lowest because of low payout

13 Desjardins Capital and profitability Capital strength also affects dividend growth potential SLF/MFC best capitalized, GWO not as well even before Putnam 1Q07 returns on adjusted surplus in a narrow range Returns do not reflect differing patterns of earnings emergence Insurance companies As at: 20-Jun-07 RoE calculations (All amounts in Cdn$ million) Ticker Latest Qtr Adjusted Bal Sheet Surplus Adj Surplus Net income attributable to common shares RoE RoAS S/H equity Common Assets as % of as % of LFY Last qtr Last qtr LTM (Common) Equity Assets Assets Q1 07 Q1 06 GWO 10, , , % 10.1% 1, , % 16.1% IAG 1, , , % 11.0% % 15.7% MFC 26, , , % 13.9% 3, , % 14.9% SLF 16, , , % 13.7% 2, , % 13.4% Key deficiency of earnings a metric that complies with accounting rules but does not necessarily reflect value added or subtracted 13

14 Desjardins EmV: Too many assumptions used? Manulife: EmV Reconciliation to Financial Statements Shareholders Equity (B/S) Add Fair Value Adjustments Less Goodwill and post-tax intangibles Net Shareholders Equity Add Pre-tax PAD Add Additional policy margins not in PAD Less tax Less cost of discount rate adjustment from valuation to cost of capital Less Cost of locked-in capital Value of In-force business EmV Lifecos earnings include even more assumption One assumption taken away by EmV and VNB approach: the timing of earnings emergence and recognition

15 Desjardins 1. Dividend yield 2. NAV embedded value For NAV, think of lifecos as analogous to exploration/production companies OIL AND GAS Reserves NAV Exploration New reserves added Geologist LIFE INSURANCE In-force business PVFP of in-force business (EmV) Sales PVFP of new business (VNB) Actuary Valuation: Premium to NAV based on exploration track record Valuation: Premium to EmV based on ability to generate profitable sales 15

16 EmV per share $50.00 $45.00 $40.00 $35.00 $30.00 $25.00 $20.00 Desjardins $ IAG MFC SLF GWO won t play MFC growth reduced by JHF dilution and forex, offset by stock issued SLF growth reduced by CLI dilution and forex IAG: strong growth but different assumptions

17 Desjardins $3.00 $2.50 $2.00 $1.50 $1.00 $0.50 VNB per share, annualized $ IAG MFC SLF Very significant measure of value added When companies acquire infrastructure, EmV may be diluted but payoff should be stronger future VNB growth, eg MFC/JHF IAG and MFC provide quarterly data

18 VNB multiples over EmV Desjardins IAG MFC SLF A function of deal activity in the industry, thus increase from 2002 How lifecos look at valuation for M&A activity Analogous to oil & gas premium to NAV IAG lower because of different (less conservative)

19 Desjardins Desjardins target prices and ratings Lifecos Target Prices and Ratings Ticker Target pricebasis for target Upside potential Rating GWO % dividend growth14% Buy Average Risk IAG EmV+3xVNB 11% Buy Average Risk MFC EmV+12.5XVNB 19% Top Pick Average Risk SLF EmV+11.5XVNB 17% Buy Average Risk 19

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