Prudential Is Well Positioned for Long-Term Growth, but We Do Not Think It Has a Moat

Equity Analyst

Henry Heathfield

With the divestment of Prudential PLC's U.K. and European operations, followed by the sale of its Jackson business in North America, Prudential is now a life and health insurer that is fully focussed on Asia and Africa, with one of the region’s largest asset managers.

Prudential is not the number one operator. However, we do think the company is gaining traction and taking market share. Its roots stand in selling life insurance to the middle classes and branching out into the industrial and urbanizing working classes. While that happened almost two decades ago, we think that is still a relative narrative. The industrial division of Prudential led to the rise of door-to-door sales. The "man from the Pru" was born and for Prudential became synonymous. While that market may have matured and this practice has generally died, Prudential’s new geographical focus harkens back to these Industrial Revolution times, just in a different part of the world. Prudential’s more mature markets of Hong Kong and Singapore speak to the origination of the business to serve the middle class. Our sense is that in these markets, Prudential has been catering more to the high net worths. Prudential’s establishment and focus on Southeast Asia is reminiscent of its sales and service to the rising industrial working class.

While Prudential may not be the biggest and it may not be the first, we think the business has historically placed strong emphasis on pricing and underwriting discipline, and yet in this region it has been successful at combining that with growth. While margins on sales such as fees and loading costs have been pressured as competition has increased, Prudential has done a prodigious job of recouping this loss of profit from administration and acquisition costs. More telling is that on average Prudential has improved the margin it makes from insurance by 5 basis points per year on average. The business hasn’t been operating for very long on a stand-alone basis. However, we think the markets and the company have some interesting features that could lead to economic profits—and, over time, a moat.

Business Strategy & Outlook

We do not award Prudential an economic moat. While we believe Prudential has not earned its cost of capital over recent years, we think a number of dynamics make this business an interesting long-term prospect.

Prudential divested its U.K. and European operations in October 2019. Prudential then divested its North American operations in September 2021. While this means there is not a lot of clean returns data for us to assess, our best guess is under the old accounting regime, assuming a more normal level of short-term investment returns versus long-term expectations, Prudential generated something in the region of 10.2% return on equity over last year. That is below the 11% cost of equity that we apply to the business. Prudential is a well-capitalized business. If we reduce the company’s capital coverage to around the 2 times required by regulators, we believe Prudential generated an 11.2% return on equity.

Prudential operates in some interesting markets where there tends to be strong growth coupled with high demand for insurance. While insurance penetration tends to be higher in some of Prudential's more developed markets, such as Hong Kong and Singapore, and economic growth tends to be lower in these regions, in the more emerging Southeast Asia markets insurance penetration is low and economic growth is in the mid to high single digits. Thus, Prudential has a very long runway for growth in many of its markets. For example, in China, where insurance penetration is only 2.4%, there is an $800 billion health insurance protection gap. Prudential has the potential market share growth for decades. Other very interesting markets for Prudential include Malaysia, Thailand, Vietnam, India, and the Philippines. We think Prudentials’ mobile application, Pulse, can really have an impact in these newly emerging markets.

For individuals, life and health insurance isn’t really a commoditized product. For example, if you wanted to buy a health insurance cover in order to protect against a potentially critical illness or an upcoming treatment, it is unlikely a consumer would just buy the cheapest cover. The product is purchased in order to provide access to better healthcare and services, and these features are very important. Pricing in health and protection insurance can therefore be relatively inelastic. A reduction in price is unlikely to materially increase sales volume. We think this means health and protection insurance companies compete on three main features:

- Which offers access to the best healthcare.

- Which offers access to the best benefits and services.

- Which has the fastest and the best customer service.

This also seems to play out in the way insurers run their business. Prudential and other quality insurers tend to take a very rational and disciplined approach to pricing, and they keep sales origination and hurdle rates within their risk appetite. Underwriting discipline has long been a Prudential strength.

Once an individual consumer or enterprise customer has chosen a health or protection provider and the relevant insurance policy, they are unlikely to switch. This is born out in high retention rates. As an insurance portfolio grows so does its pool of risks, and this increases the diversification benefit and lowers regulator-driven capital requirements. All things being equal, with the same leverage and investment portfolio risk, this results in a rise in returns delivered to shareholders. We think this means that in a relatively inelastic pricing environment with stable demand for health and protection policies, and with high retention rates, a business is likely to reach an inflection point where it may just need to annually replace the policies it has lost with new business. As acquisition costs fall and economies of scale improve with expenses, a health and protection insurer can reach a point where maintainable economic returns are achievable if it has developed good switching dynamics. 

With Prudential's mobile application, Pulse, the business is working toward these competitive dynamics. For example, the greater the number of Pulse downloads the greater the number of bite-sized product conversions. While those individual small products may not generate much revenue or even profit, the power of Pulse lies in nurturing those users and their bite-sized product into a larger full-size insurance policy sales.

Prudential is not the number one provider in Asia of health and protection insurance. However, we do think the business tends to take market share from many of its peers. For example, we think Prudential has consistently increased its market share in Hong Kong to around 7.5%. In India, we think ICICI Prudential has around a 15% market share, and we think the company holds a similar market share in the Philippines. In Singapore and Vietnam, this share is approaching 20%. In Mainland China, while Prudential increased its market share among foreign joint venture operators by over 10 percentage points over less than a decade, across the whole of China Prudential still only holds a market share of less than 1 percentage point. This makes it a phenomenal potential growth market, particularly as many of the local operators tend to focus more on products as investments. This has been the driver behind Prudential’s design of city clusters through which it can tackle this market.

None

Economic Moat

Prudential

M&G Investmets Is an investment manager in the UK and overseas. Current chief investment officer of M&G Investments is Anne Richards. It is an autonomous business within the Prudential Group, running its own retail and institutional funds operation and functioning as the asset manager for Prudential in Europe. Currently M&G is the official sponsor of the RHS Chelsea Flower Show. M&G invests in and manages a wide range of assets including Equities, Fixed Income and Property. M&G also manages more esoteric assets within the private finance arena such as Structured Products (including CDOs), Leveraged Finance, Project and Infrastructure Finance.

M&G Investments

Jackson National Life is a U.S. company that offers annuities for retail investors and fixed income products for institutional investors. Jackson subsidiaries and affiliates provide specialized asset management and retail brokerage services. Jackson is a subsidiary of the British insurer, Prudential plc, which acquired the company for $608 million in 1986. That company is unrelated to the American insurance conglomerate, Prudential Financial.

Jackson National Life

Prudential Plc is a holding company, which engages in the provision of insurance and financial services. It operates through the following geographical segments: CPL, Hong Kong, Indonesia, Malaysia, Singapore, Growth Markets and Other, and Eastspring. The company was founded on May 30, 1848 and is headquartered in London, the United Kingdom.

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Prudential plc, a life insurer, has experienced poor share price performance despite strong earnings and dividends growth. Lessons for income-focused investors: avoid companies with multiple unrelated businesses and don't make optimistic assumptions about future growth rates. Selling Prudential at a loss is a rational decision due to its lack of focus, weak competitive advantages, and unattractive share price and dividend yield.

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