An insurance company almost in a league of its own. With earnings in Asia expected to double in five years, a strong focus on technology that increases profitability, increasingly satisfied customers, more stability and a focusing of the corporate structure, we are very satisfied co-owners. At the same time, the share price is so attractive that further growth is currently free. All things we appreciate.
Prudential Plc is headquartered in London, but most of the value is found in an Asian business consisting of a salesforce of more than 600,000 agents and a number of products that can help an under-insured population get better treatment and higher standards of living. While on paper insurance seems like a simple service to provide, it can have a huge impact on the insured individual.
The name Prudential is based on the word ‘prudent’ – i.e. to be careful. For Prudential Plc’s many customers, the insurance policies are precisely about being prudent. It is about being insured and being prepared if something unexpected should happen.
Prudential mainly sells health insurance, and many of the inhabitants of Asia face a significantly larger proportion of medical bills that they have to pay for themselves than is the case in more developed western countries. In fact, it is estimated that the proportion of medical expenses people pay for themselves, is more than 40 percent in Asia, compared to around 15 percent in the UK and 11 percent in the United States – and there are no indications that this is changing significantly in Asia.
Thus, for Asians, it is very prudent to buy health insurance such as that provided by Prudential (or AIA, another one of our companies). In addition to people having to pay a large proportion of their medical bills, there are also other health care issues in Asia. The scarcity of hospital capacity to take care of the sick is just one of many issues worth mentioning here.
However, from the point of view of owning this company, these problems become opportunities, because Prudential’s insurance customers can get assistance getting a doctor’s appointment or a hospital bed and thus getting treatment. An advantage only available to the insured.
Recurring payments add an element of stability
Prudential has had an Asian business unit for more than 100 years, but it was only around 20 years ago that it became a serious area of emphasis when Mark Tucker, who would later become CEO, was sent to Asia to increase the insurance business. However, there was one hitch – Mark Tucker was not allowed to establish a business that would require a lot of capital, as there was not much capital to spare from the rest of the business.
This led to the major focus on health insurance that today represents around 70 percent of the new business profits in the region. Health insurance has a high proportion of annual, ongoing payments that make up more than 90 percent of the annualized new premiums in Asia. Additionally, the earnings are significantly higher than from, for example, single premium policies that Prudential also sells which consists of the customer making one single large payment. The recurring payments are a positive factor as they create stability and predictability – maintaining a previously signed insurance policy does not depend as much on the economic ups and downs as single premium policies.
Currently, Prudential has an impressive and value creating Asian business unit which is a familiar and respected brand. For example, its logo is proudly displayed at Hong Kong’s harbour. This well-known brand is an advantage when looking for new customers – but also when hiring new employees, as the company is known as being a good place to work, even for the highly educated. At the same time, the company’s legacy as a British company is something that makes the customers feel more at ease; they see Prudential as a trustworthy company. This has allowed Prudential to create a leading business in 14 Asian markets where it holds a Top 3 position on 10 of them.
The pace of development on the Asian markets has been a very significant factor in Prudential rapidly becoming the company it is today. Asia represented around two thirds of new business profits in 2018, while this was under 40 percent at the turn of the millennium. In the same period, the quality of the Asian business has improved, among other things due to a major focus on selling health insurance products which generate higher earnings and have an impressive return on invested capital. For example, the investments in China has a pay-back period of three years – equivalent to an annual return on investment of 33 percent. This is a higher level than Prudential as-a-whole performs today, where the return on equity is around 25 percent, but this is likely to increase even further.
New customers are completely “fresh recruits”
when it comes to insurance600,000 sales agents in Asia are working to maintain and grow the business, but this host of sales agents operate differently from market to market. While the agents in the major cities such as Hong Kong and Singapore will often be sitting in fancy offices with great views, the agents in, for example, Indonesia, will be working on a much more low-tech level, travelling to villages by bicycle in attempt to sign new customers. Many of these customers have not previously been insured, and therefore it is often initially about convincing them of the advantages of being so – and then, subsequently, convincing them that Prudential is the best insurance company for them to choose. Two out of three new customers have never been insured before.
In addition to the significant salesforce, Prudential also collaborates with the Asian-focused UK bank, Standard Chartered, and Chinese, CITIC. The collaboration with CITIC is in the interesting Chinese market, in which regulations have previously prevented Prudential from owning more than half of its subsidiary. Prudential still maintains the collaboration, however, despite the fact that these regulations have been changed in the last year. The Chinese market has huge potential (as described in more detail on our description of AIA), and Prudential is currently allowed to operate as an insurance company in 18 Chinese regions. In practice, the insurance companies do not get permission to operate in more than one new region per year. Therefore this is a competitive advantage for Prudential.
Despite high growth rates, there is still a long way to go until the markets are mature. As a whole, Asians have significantly less insurance cover compared to Westerners, and with the lower assistance they receive from their public sectors, there are no reasons as to why their needs for insurance should be any less. For example, it is assessed that the insurance penetration in China is at around two percent today, but the Chinese government wants this number to reach five percent by the end of this decade. This figure is around seven percent in the United Kingdom hence there is still a lot of potential.
While it is possible to expand into new markets over the coming years, such as new regions in China or new countries in South East Asia, there is so much potential in the existing markets in Asia in which Prudential operates already. The competition on price is a lot tougher on many European and North American
insurance markets. On western markets, competition is based on winning customers away from the competitors, and this often leads to lower prices. On many Asian markets, however, the insurance companies are growing by expanding their markets, and therefore the earnings are expected to be able to stay at their impressive levels. In Prudential, the new business profits are more than 60 percent of annualized new premiums, and the return on equity is close to 30 percent in Asia. As mentioned, the majority of premiums consist of annual recurring premiums wherein the annual retention of insured customers is around 90 percent and the recurring premiums represent almost 98 percent of the annualized new premiums. The current business is thus likely to create free cash flows for the next 40 years. This creates a stable and very predictable value creation – and to an extent that only very few European “peers” manage to achieve.
From small fry to market leader
Prudential does not just consist of an Asian business unit, it also operates in the United States and the UK. The UK part of the business, consisting of the large asset management company, M&G, and the legacy insurance business in the UK, are expected to be split off from the remaining business and become independently listed during 2019. Prudential is, for now, holding on to the American business unit.
In the United States, Prudential, via a company called Jackson, has sold variable annuities, in particular since the financial crisis in 2008, and in this period it has gone from being a small player in the market to becoming the market leader. For several years, the growth in premiums has been limited, as the regulatory environment has been very unclear on how these could be distributed. The already signed American business has the greatest financial risk profile in Prudential, and therefore the day-to-day management in the United States is using quite a bit of energy and effort on figuring out how the risk of the products can be hedged and thus how a potential negative financial impact can be softened.
After splitting off the UK part of Prudential, earnings are expected to be equally split between Asia and North America, with Asia representing 75 percent of new business profit. The reported earnings in Asia are expected to be able to grow by around 13-15 percent per year over the next 5 years and thus double in size from what they are today. The growth in Asia has been in the double digits for the last nine years.
The CEO is Mike Wells, who has been at the helm since 2015, but he has been with Prudential since 1995. Before 2015, he had a successful career in the American business unit, in particular with building up the sales organisation. The CFO is Mark FitzPatrick, who joined Prudential in 2017 when former CFO, Nic Nicandrou, was put in charge of the Asian business unit.
Management at Prudential prides itself on making insurance sound as simple and obvious as it perhaps is – on paper. A customer will pay a certain amount today in order to have some or all of the costs covered if a number of defined events take place. However, a long-term value creating insurance business is not quite so simple. It is about making the right kind of deals with the right kind of customers at the right prices.
A major focus on technology
Prudential maintains a major focus on using technology to drive this process and on how technology can be used to assist the sales agents in optimising the individual insurance contracts signed with the customers. Previously, for example, it could take up to a week from the time the sales agent had the first conversation with a potential customer to the time when the agreement could be forwarded for signing. This meeting was basically about the circumstances in the customer’s life and what kind of insurance products and cover might be relevant in this context. Afterwards, the sales agent would have gone back to the office to have the company’s actuaries run the numbers on what this would cost. The longer the period of time between the first meeting and the time at which the customer has the offer in hand, the higher the risk that the customer changes his mind.
Today, technology can streamline this process significantly, and internet access and apps will allow the sales agents to access a list of relevant insurance products and extra services based on the customer’s data, and it is even possible to have an offer on the size of the insurance premium within half an hour. Thus, the process is significantly faster, and all things equal, the probability of getting an insurance policy signed is higher.
Technology will also benefit the customers. Claims for damages can be sent digitally, and the processing time is faster if this approach is taken over trying to do it over the phone or by sending in forms by regular post. In addition, Prudential has entered into a collaboration with app developer, Babylon, and this collaboration is intended to optimise any potential medical treatment processes that the customers will need to go through. The app will allow the customer to enter their symptoms, and together with having access to the patient’s medical journals, the app will be able to assist with an indication of a diagnosis and pass this data on to the customer’s doctor. Thus, the doctor will have the correct information available faster, and it will be easier for the doctor to make the correct diagnosis and suggest the right medical treatment process as well.
The corporate culture and the constant focus on creating long-term value are extremely strong at Prudential. At Prudential, they focus on allocation capital in order to maximise the long-term high earnings and free surplus. Management’s remunerations are linked to the progress made in both these parameters. Their bonuses are not just based on the growth of reported earnings, but just as much on how these earnings are converted into cash flows that can either be reinvested in the business or passed on to the shareholders.
Prudential is very disciplined in its dividend policy, at about 1.5 British pounds per share – amounting to almost 3 percent of the current market value. Dividends are growing by five percent a year, with dividends sometimes growing at a faster rate. Step changes in the dividend, however, will only be approved in situations where management finds it unlikely that this would put unnecessary financial pressure on the company, should a downturn occur. Dividends have increased annually since 2004 and were not reduced during the financial crisis, unlike many financial companies, which had to cut their dividends in order to retain capital.
Today, Prudential’s market price is equivalent to less than ten times current year’s earnings, and we find this very attractive for a company that faces the prospects of double-digit earnings growth, a high and increasing return on capital and an attractive dividend yield. The market price is a very poor reflection of the insurance business that Prudential has already signed. Along with their quarterly reporting, the company makes a conservative estimate of future cash flows based on already signed business (an embedded value of in-force business), and currently, the market price is lower than this estimate. It could therefore be argued that future growth is free when you buy a share in Prudential. Prudential was founded in 1848 and is listed on the London Stock Exchange. The listing in London might have an impact on the low and attractive valuation. But make no mistake the gold is found in The East.