First Eagle sets a proceeds test for Japan's insurer unwind

First Eagle's John Masi said allocators should strip gains from Japanese insurers' cross-shareholding sales out of reported profit, arguing they flatter results and reveal little about the underlying business.

The Nov. 5 commentary, published by Insurance AUM Journal, said governance reform, regulatory scrutiny and industry misconduct are speeding the unwinding. The holdings were kept partly to reinforce commercial relationships rather than solely to earn a return, Masi said. They tied up capital, raised equity-market exposure and made it harder to judge whether insurance was priced correctly.

For an allocator underwriting Japanese insurer equity or credit, the diligence starts with stripping equity-sale gains out of reported profit. The figures that matter then are the balance sheet, reserve discipline and the prospective return on each retained yen.

The unwind tests insurers twice, Masi said. First, with reciprocal shareholdings gone, insurers compete more on service and underwriting discipline, and the result should reveal the strength of the business underneath.

The second test is what management does with the proceeds. Repurchases below intrinsic value can raise value per share, he said. Reinvestment can strengthen a domestic franchise that holds a competitive advantage, or an overseas business whose underwriting, capital, data and reinsurance capabilities reinforce one another. Acquisitions made mainly to sustain growth risk leaving shareholders with a loose collection of businesses. The cap on all of it is the loss buffer: insurers must keep ample resources for catastrophes and unexpected losses, which limits how much released capital can leave the balance sheet.

“We think it’s important to distinguish strong capital allocators from companies merely selling holdings,” Masi said. Reported profit can mislead because equity-sale gains are large but non-recurring and do not reflect underlying profitability.

Masi said the work is a multi-year conversion of underused capital into stronger businesses and higher intrinsic value per share, not primarily a trade on Japanese growth, interest rates or the yen. “The opportunity may be substantial, but it is not uniform,” he said. Bottom-up research is how he would separate teams that turn finite capital release into durable compounding from those that do not. First Eagle has written for insurance balance sheets before, as Private Wealth Daily previously reported.

The same two questions reach any insurer that shrinks an equity book and books the gain: whether the business holds without reciprocal ties, and what the released capital earns. The second is answerable company by company, in buybacks, underwriting capacity and the return on retained yen, rather than with a view on Japan.