Insurance companies have avoided direct damage from the credit crisis caused by U.S. subprime mortgages. They also seem to have avoided collateral damage. And that, presumably, should make them the favoured stocks in the financial sector.

So far, though, investors have restrained any enthusiasm they might feel toward insurance companies. Most stocks are in rising trends, but trading volumes have slackened since the market’s reversal in August.

Since yearend 2002, when the new S&P/TSX index system began, to yearend 2006, the insurance industry group has beat the market. It gained 104%, while the S&P/TSX composite index gained 95%. This year, however, the insurance subin-dex has lagged. Since the beginning of the year until late October, it has gained 7% vs the composite index’s 11% rise.

Earnings changes, however, have been at variance with price changes. This year, insurance industry earnings went up 14%, while S&P/TSX composite earnings dropped by 5%. From yearend 2002 to yearend 2006, insurance company earnings gained only 73%, well behind the overall market’s 425% gain.

On a value basis, the insurance group looks solid, as it traditionally has. The Canadian industry has three dominant life insurers — Manulife Financial Corp., Sun Life Financial Inc. and Great-West Lifeco Inc., in order of size.

Two additional major players are property and casualty insurer Fairfax Financial Holdings Ltd. and life insurer Industrial-Alliance Insurance & Financial Services Inc. The new kid on the block — and a large one, at that — is Netherlands-controlled ING Canada Inc. , now this country’s largest P&C insurer.

Differences between the life and P&C insurers lead to some clear differences in valuation. Some companies also operate outside Canada — which accounts for a major difference between ING and Fairfax, for example.

Balance-sheet strength is normal for the industry, with shareholders’ equity around 10% of assets. Manulife, the industry giant, has the lowest ratio. The new kid, ING, has an unusually high ratio.

The “cheapest” of these, in terms of price/book value and price/average earnings, is Sun Life. It has also been the slowest grower in the group, and its return on equity has been generally lower.

For financial stocks, price/book value is a sound basis for valuation. Currently, Manulife and Sun Life are at the high end of their valuation ranges of the past five years. Manulife has traded as high as 3.1 times book value and as low as 1.6 times in that time frame. Sun Life has traded between a high of two times book value and a low of book value.

The insurance group’s stock prices are relatively high compared with average earnings over the past three fiscal years. ING is the exception, trading at eight times average earnings. But the company is new on the scene — it went public at the end of 2004 — and this low multiple may reflect the belief its fast growth will slow. ING’s pretax earnings have more than tripled since 2003.

Great-West, a unit of the Power Corp. group, is the life insurance leader in profitability and growth. Hence, it trades at the highest multiple of book value. Per dollar invested, it offers the lowest value in total assets among the life insurers.

A trend to watch regarding Manulife is profitability. Average return on equity has been lower the past three years than in the preceding three years.

Fairfax is the odd man out in the insurance group, beset by a series of losses and operating problems, as well as litigation. As a result, shareholders’ equity (book value) has dropped since 2001. Revenue growth has been stagnant; its total revenue in 2006 finally topped the preceding high, set in 2001.

In stock market action, Manulife shares have broken the $41-a-share barrier, which had marked the peak of a couple of its stock’s recent advances.

In contrast, Great-West shares have been unable to rise above previous recent highs of around $38 each, and Industrial-Alliance shares, at $38.50 each, are below their recent high. Sun Life shares dropped sharply in the spring and have yet to reach the spring high of almost $54 a share.

Despite several corrections, Fairfax shares have been in a rising trend since mid-2006. The high so far has been $279. IE



Note: Carlyle Dunbar has life insurance with Sun Life and auto insurance with ING Canada.

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