Life insurers have been particularly valuable and necessary during the coronavirus pandemic, but they have also struggled financially under the weight of increased claims. Investors have, for the most part, stayed away from companies in this industry as most of the returns have been negative throughout the health crisis.
Some stocks in this industry, like Prudential Financial (PRU 2.74%), have become undervalued as a result and may be worth considering as we move into 2021. Let's take a look at Prudential, one of the largest life insurance companies in the U.S. Is it a buy?
A good quarter for Prudential's investment arm
Prudential is primarily known as an insurance company, but it is a diversified financial services firm with three primary revenue streams. In addition to the U.S. and international insurance businesses, it also has an investment arm, PGIM Investments.
That diversification helped the company offset losses in its U.S. insurance business, its largest segment of the income pie. The U.S. business produced a 4% loss in operating income to $873 million due to several factors, including less favorable underwriting results due to higher mortality rates caused by the pandemic and lower fee income from the annuities business due to 0% interest rates.
But those losses were offset by PGIM's 59% increase in income to $370 million. The increases were driven by strong inflows into its fixed-income funds and higher fee income related to higher account balances. Assets under management reached a record high of $1.4 trillion, a jump of 11% year over year.
The international insurance business also saw gains in the quarter, up 7.4% year over year to $775 million, due primarily to more favorable underwriting results in overseas markets that were not hit as hard by the pandemic.
Heading into 2021, Prudential should be able to continue the positive momentum for a few reasons.
Change is good
Prudential has made several moves to better position itself coming out of the recession. First, the company has put a renewed focus on expense management. It has sold or is in the process of selling two of its underperforming businesses, Prudential of Korea and Prudential of Taiwan. These divestments will improve Prudential's already solid cash position, as the company had $6.1 billion in cash and liquid assets at the end of the third quarter, unchanged year over year.
In addition, Prudential launched an expense management plan at the start of 2020 to reduce expenses by $750 million through 2023. At the end of the third quarter, it had already achieved $135 million in savings. The initial plan was to save $500 million by 2023, but that was bumped up to $750 million after the pandemic hit, as the pandemic has facilitated new ways of operating.
Furthermore, Prudential embarked on a plan last year to de-risk its annuities by launching its FlexGuard indexed annuity and discontinuing its traditional variable annuities with guaranteed living benefits. FlexGuard lets investors choose their level of protection, or buffer, from interest rate risk. The buffer will vary by strategy, term length, and the index that is selected. This annuity made up about 38% of Prudentialʻs annuity sales in the third quarter and became the fastest annuity of its kind to reach $1 billion in sales.
A strong company at half book value
While the annuity market will likely remain slow in 2021 as changes in interest rates are unlikely, the sales strength of this product should temper some of the losses. Plus, according to a report by Deloitte, the life insurance market should bounce back in 2021 -- premiums are expected to grow 2% after declining 8% last year.
Prudential's stock is off to a good start in 2021, up about 9% as of Tuesday's prices. The stock is way undervalued, trading at roughly half its book value. I think it's a good value investment right now, with the added bonus of a great dividend with a yield of 5.2%. Prudential has been around a long time and is one of the market leaders in the insurance business -- and it's making the right moves to ensure that it continues its leadership position.