If your clients are looking to invest in the depressed global financial services sector, you may want to point them toward life insurance companies. These may be better bets than global banks.

There are two key reasons for this. First, barring New York-based American International Group Inc., no other lifeco has received government bailouts or capital injections. Second, lifecos have significant holdings of corporate bonds, which many global money managers expect to appreciate sharply in price this year.

In fact, some lifecos have as much as 50% of their assets in bonds, says Charles Burbeck, an independent global money manager in London. Corporate bonds of quality companies, he says, have “ridiculously high yields at the moment.” So, if there’s some recovery in their prices, there will be big gains.

Daniel Nuckles, a portfolio manager with Franklin Resources Inc. in San Mateo, Calif., agrees. “There’s a lot of potential upside,” he says, “because financial markets are pricing in a depression.”

The lifecos’ capital adequacy issues, Nuckles notes, will probably go away once the economy recovers and equities prices increase. But if the bear market persists for another six months, he warns, insurers might have to boost capital levels.

Because of the long-term nature of lifecos’ liabilities, their business model is complicated. Actuaries estimate future payouts and insurers invest the monies raised from policyholders’ premiums to fund those future liabilities. Lifecos offer a wide array of products, including whole life, term life and medical and disability insurance, as well as annuities and retirement products with guarantees. Some of the retirement products are linked to the performance of equities markets. As well, some global lifecos offer property and casualty insurance.

Growth prospects for the global life-co industry are good. Aging populations in the industrialized world — particularly in Europe, where governments are cutting back on support — need to save for retirement. Demand is likely to be even greater in emerging economies, as incomes rise and consumers buy insurance. But, Burbeck says, that is a longer-term prospect: “People typically buy a car or a television before they buy insurance.”

Three U.S. lifecos that could do well are Columbus, Ga.-based Aflac Inc. (formerly American Family Life Assurance Co. of Columbus), and Assurant Inc. and MetLife Inc., both based in New York. These three have not cut their dividend payments during this recession. Another possibility is Beijing-based China Life Insurance Co. Ltd.

Here is a closer look at the four companies. All figures are in U.S. dollars unless otherwise noted:

> Aflac Inc. conducts about three-quarters of its supplemental health and life insurance business in Japan. In the U.S., Aflac provides voluntary insurance products — such as accident/disability and cancer coverage — sold at work sites.

Burbeck considers Aflac’s stock to be a play on aging populations in the industrialized world. He is impressed with the company’s strong growth in Japan over the past 15 years, despite virtually no economic growth in that country. Although competition in Japan is increasing, Burbeck thinks this could be offset by stronger growth in the U.S., as employers cut back on medical costs, increasing demand for supplemental policies.

Nuckles also likes Aflac’s stock, pointing out that many of Aflac’s products don’t have many competitors.

In the fiscal year ended Dec. 31, 2008, however, Aflac’s earnings were pulled down by realized investment losses of $655 million, vs a gain of $19 million in 2007. In the fourth quarter alone, there was a $117-million realized loss related to three Icelandic banks.

These investment losses overwhelmed the positive affect of the rise in the yen against the US$. As a result, Aflac reported net income of $1.3 billion in 2008, vs net income of $1.6 billion in 2007, despite growth in revenue — $16.6 billion in 2008 vs $15.4 billion in 2007.

Aflac also has considerable exposure to European perpetual preferred shares. This was behind the downgrading of Aflac’s rating to an A- from an A by Oldwick, N.J.-based insurance rating agency A.M. Best Co. Inc. on Feb. 2.

These European hybrid investments have also caused some concern at New York-based J.P. Morgan Securities Inc. Although its Feb. 3 report stuck with a “neutral” rating for Aflac’s stock, the 12-month price target was slashed to $27 a share from $53. (New York-based UBS Securities LLC also rates Aflac’s stock as “neutral,” but with a much higher 12-month price target of $45. The stock closed at $23.69 a share on Feb. 9.)

@page_break@“Unlike other insurers with balance-sheet uncertainty,” the J.P. Morgan report says, defending the “neutral” rating, “Aflac’s underlying franchise and growth potential are largely intact.” The report estimates that Aflac’s scale and cost structure gives it a 15%-20% cost advantage over competitors, which allows the company to offer lower-cost products and pay higher commissions.

That said, the J.P. Morgan report does point out that if the perpetual preferreds are reclassified as equities, Aflac would record significant losses, impairing its statutory capital position. The report’s authors don’t expect this but are “attentively watching to see how European governments will treat Tier 1 and upper Tier 2 securities [virtually all Aflac’s holdings] of banks that are being nationalized.”

Furthermore, Aflac accounts for its fixed-income portfolio on a “held to maturity” basis, which, the J.P. Morgan report says, overstates Aflac’s book value. If rating agencies start to treat these securities as available for sale, that would reduce Aflac’s capital flexibility.

As of Dec. 31, Aflac had assets of $79.3 billion; shareholders’ equity was $6.6 billion. Its 467 million common shares outstanding are widely held.

> Assurant Inc. is a specialty insurer that provides both life and P&C insurance, although life is a bigger part of its offering than P&C. Life and health products are grouped with dental, disability and funeral insurance. On the P&C side, Assurant offers creditor-placed homeowners’ insurance and tracks the policies on behalf of these third parties. Assurant also offers home-related insurance, coverage on leased and financed equipment, debt protection and credit insurance, and extended service contracts and warranties.

What makes Assurant’s stock a defensive play in the current environment is that the company doesn’t offer retirement products with guarantees. As a result, Assurant is not exposed to equities risk. Analysts note, however, that when equities markets rebound, Assurant won’t experience the earnings uptick that other life-cos will.

Still, a Feb. 5 J.P. Morgan report expects that most of Assurant’s life insurance products will grow at above historical levels, offsetting a slowing P&C business. “The stock warrants a premium multiple,” the report notes, “given its lack of exposure to the equities markets, below-average investment portfolio risk and stable capital position.”

Nuckles also likes Assurant. As with Aflac, he says, Assurant’s product lines don’t face a lot of competition and it has a “pretty clean” balance sheet. Although the insurer has some asset-backed securities exposure, it’s “pretty minimal.”

The J.P. Morgan report recommends overweighting Assurant, with a 12-month price target of $36 a share (vs $26.52 on Feb. 9). “The stock is trading close to the life insurance group,” the report notes, “but with fewer balance sheet and operating concerns than other life insurers.”

In the fiscal year ended Dec. 31, Assurant reported net income of $447.8 million, down from $653.7 million in 2007; 2008 revenue was $8.6 billion, vs $8.5 billion in 2007.

Total assets were $24.5 billion as of Dec. 31, vs $26.8 billion a year earlier. Debt remained at $972 million and shareholders’ equity was $3.7 billion vs $4.1 billion. Assurant’s 118 million common shares outstanding are widely held.

> China Life Insurance Co. Ltd., launched in 2003, is the largest life-co in China, accounting for about 40% of industry premiums.

Burbeck calls China Life a “leveraged play on the penetration of life insurance in China and on the China market as it invests in Chinese equities.” Penetration of insurance, as well as other financial services products, is relatively low in China. But as incomes rise, consumers eventually turn to insurance.

Even if premium growth slows along with the economy, Burbeck notes, long-term growth prospects remain attractive, as China Life’s bigger sales network gives it an advantage over its competitors.

China Life did issue a warning that 2008 net income could be down by more than 50% from 2007 levels, which sent its share price into a slump. It closed at HK$23.50 on Feb. 9, down from its peak of HK$53.80 in October 2007. (HK$1 equals US13¢.)

Yet China Life’s share price hasn’t been hit as hard as those of other Chinese stocks. China Life is strong financially, says Burbeck, and its lower price makes for attractive valuations; a year and a half ago, the shares were too expensive.

J.P. Morgan and UBS, in their respective Jan. 20 reports, seem to agree. Both rated China Life’s shares a “buy,” calling the current price an opportunity to pick up the stock at attractive prices. Their 12-month price targets are HK$28.40 and HK$26.10, respectively.

China Life reported net income of 16 billion Chinese renminbi (¥), or $2.3 billion, in the six months ended June 30, 2008, vs ¥23.4 billion in the same period a year earlier. Revenue was ¥99.3 billion in first half of 2008, vs ¥101.4 billion in 2007.

Total assets were ¥964 billion as of June 30, with ¥42.2 billion in cash or equivalents. Debt was very low, at about ¥10 billion, and shareholders’ equity was ¥166.7 billion. China Life has 28.3 million shares outstanding and is widely held.

For the past three years, China Life has paid an annual dividend: 42¢ (HK$) a share in June 2008, 14¢ in June 2007 and 5¢ in May 2006.

> Metlife Inc. is one of the largest U.S. insurance companies, with assets of $501.7 billion as of Dec. 31. Its institutional division provides group life, non-medical health insurance, and retirement and savings products. The insurer also offers individual life and annuities, and has a P&C division that offers automobile and home insurance.

MetLife operates globally, with offices in Australia, Belgium, Britain and Japan, as well as in emerging economies, including Argentina, Brazil, Chile, China, Hong Kong, India, Korea, Taiwan and Uruguay.

MetLife has some cost-cutting potential, including selling off non-core businesses, Burbeck says. The company is also conservatively managed — both operationally and in terms of valuing assets — and takes a very long-term view. MetLife has also kept its reputation intact during the credit crisis and has a strong brand. Burbeck expects MetLife to take market share away from weaker competitors and to benefit from growth in emerging markets, in which it has the advantage of being an early entrant.

According to a Feb. 4 J.P. Morgan report, MetLife’s earnings will hold up “relatively better than its peers” over the next few quarters; the report calls MetLife “the most defensive large-capitalization life insurer if markets remain weak” — adding that “MetLife’s superior franchise, broad distribution and strong capital position will enable it to take advantage of the weakened competitive state of other life insurers.”

However, the report does express some concerns about MetLife’s investment portfolio, which has below-average holdings of BBB bonds and low-rated residential and commercial mortgage-backed securities and above-average allocations of subinvestment-grade bonds and commercial mortgages. The portfolio also has higher equities leverage, which magnifies the impact of investment losses when markets weaken.

That said, J.P. Morgan report doesn’t think MetLife will need to raise more capital. The insurer completed a $2.3-billion public offering this past October “for general corporate purposes and potential strategic acquisitions.”

As a result, the J.P. Morgan report recommends overweighting MetLife stock but lowered the 12-month price target to $38 a share from $42.

(A Feb. 4 UBS report rated MetLife a “buy” and maintained a previous $35-a-share target. MetLife’s shares closed at $31.28 a share on Feb. 9.)

MetLife reported net income of $3.2 billion in the fiscal year ended Dec. 31, down from $4.2 billion in 2007, on 2009 revenue of $51 billion (vs $47.2 billion in 2007).

Assets were $501.7 billion as of Dec. 31, down from $559.1 billion a year earlier. Cash was at $24.2 billion vs $10 billion, and long-term debt was $9.7 billion vs $9.1 billion. But shareholders’ equity was way down, at $23.7 billion vs $35.2 billion. There are 753.6 million shares outstanding, of which directors own 30.7%. IE