Insurance companies are facing some major headwinds in the second quarter. Not only are they confronted with the drag on earnings from a 0% interest rate environment, the industry is also faced with unprecedented financial hardships caused by the novel coronavirus pandemic. Brian Duperreault, CEO of American International Group, said in early May that COVID-19 will be "the single largest CAT [catastrophic] loss the industry has ever seen."
Overall, insurance stocks have held up better than the overall financial sector. The average insurance stock is down about 29% year to date, compared to the average financial-sector stock, which is down 33%. Prudential Financial (NYSE:PRU) trails both with a decline of about 43% this year, through Thursday's close. Is this a stock worth buying or holding?
Brutal first quarter
Prudential had a brutal first quarter with a net loss of $271 million, down from net income of $932 million in the first quarter of 2019. Earnings per share dropped from $2.32 per share a year ago to a net loss of $0.70 in the first quarter of 2020. Adjusted operating income was $939 million, or $2.32 per share, down from $1.3 billion, or $3 per share, in the first quarter of 2019. The company views adjusted operating income as a representative measure of its performance, as it takes into account ongoing operations and the underlying profitability of its businesses.
All segments of Prudential's business were down, including insurance, investment management, international, and retirement solutions. The losses were driven by lower variable investment income and decreased underwriting earnings, caused by unexpectedly low interest rates and higher mortality rates due primarily to COVID-19.
The good news is that Prudential has a rock-solid balance sheet to handle these losses. The company has $5.3 billion in highly liquid assets, versus $5.5 billion in the first quarter of 2019. In March, it completed a $1.5 billion senior debt issuance, including a $500 million green bond. These actions will enhance liquidity and cover maturities through 2021. Also, Prudential paused share repurchases and sold off Prudential of Korea to KB Financial Group for $1.9 billion, further bolstering its liquidity. Plus, it has a $4 billion credit facility.
"We're confident in our ability to successfully manage in this environment in large part due to the robust operational and financial risk framework that we put into place after the Great Recession of 2008. This framework prepared us with a playbook to address multiple stress scenarios, including pandemics and economic conditions that are more severe than what we are currently experiencing," Chairman and CEO Charles Lowrey said on the first-quarter earnings call.
Outlook is blurry
Prudential faces more tough times ahead as the pandemic continues to devastate families and cause economic hardship. On the earnings call, CFO Ken Tanji discussed the potential effect of the pandemic through the rest of 2020. Using a baseline of 100,000 COVID-19 deaths in the U.S. and 40,000 in Japan, the earnings impact from net mortality in 2020 would be around $200 million on the insurance company. If the spread of COVID-19 is substantially contained in the second quarter, the earnings impact would be an approximately $135 million, said Tanji, with lower impact in the second half.
"Also, as we continue to support our employees and families during this difficult time, we expect to incur additional costs, primarily related to sales support, employee health protection, technology and other expenses," Tanji added. "In 2020, we estimate these costs will be approximately $230 million with $115 million of these costs in the second quarter."
Buy or hold?
But, as Tanji acknowledged, there is a great deal of uncertainty surrounding how the pandemic will play out over these next few months. That creates ambiguity for the company and investors. As a result, until there is more clarity on the pandemic, now is probably not a good time to buy Prudential.
However, with its excellent balance sheet and generous dividend, it's not a bad stock to hold if it's already in your portfolio. This week the company announced a $1.10-per-share quarterly dividend to be paid out in June. That's a 10% boost over a year ago, and the stock yields more than 8% based on Thursday's closing price. The company has maintained or raised its dividend every year since 2009 -- one more sign that even in choppy seas, it can still be a rock.