Ameriprise Widens Its Moat

We've upgraded our economic moat rating for

In general, insurers do not benefit from favorable competitive positions. They are in the business of selling commodified insurance products to consumers who attribute very little value to brand. Industry competition is fierce, and there is a high degree of cost uncertainty. Because of the long duration attached to many of the products they sell, insurers do not necessarily know their cost of goods sold for a number of years, allowing them to underprice policies without knowing it. Firms have a large incentive to chase growth without regard for profitability, a cycle that repeats itself as competitors are forced to match artificially low prices or risk losing business.

From our perspective, insurance and annuities are very mature, and insurance products are mostly commodities that can be replicated by a competitor fairly easily. In fact, most companies lose money on underwriting, and they rely heavily on investment income to make up for underwriting losses. Since the typical life insurer is operationally leveraged to the state of the capital markets, over which it has no direct control, we think it is difficult for most life insurance companies to generate consistent excess returns, a requirement for an economic moat.

On the other hand, we believe Ameriprise has built a moat around its asset management and wealth management businesses. Although the switching costs might not be explicitly large, the benefits of switching from one asset manager or wealth manager to another are at times so uncertain that many clients simply stay where they are. As a result, money that flows into asset and wealth management firms tends to stay there, creating significant asset stickiness.

In our view, Ameriprise has a narrow moat around its asset management, financial planning, and wealth management operations. With one of the largest agent channels in the industry, Ameriprise has unquestionable scale. Since its 2005 spin-off from American Express, Ameriprise has gradually moved up the value chain to provide customized services and financial planning solutions to the mass affluent and affluent client groups. Its focus on personal relationships helps the firm build on its switching-cost advantage over retail clients, even though they tend to be less sticky than institutional money. Additionally, by positioning itself as a one-stop shop for baby boomers, offering advice in financial planning, fund investment, and insurance purchase, the firm makes it that much harder for boomers to switch to another provider.

We view intangible assets as another durable source of moat for the firm. Thanks to its previous association with American Express, Ameriprise Financial is a nationally known brand in the advisor network and retiree community. The firm offers mutual funds from nearly 300 fund families, representing more than 3,500 mutual funds on its brokerage platform. The size and scale of its operations, strength of its brands, and diversity of its assets under management by asset class, distribution channel, and geographic reach also provide Ameriprise with a leg up over competitors.

Columbia Acquisition Put Ameriprise on a New Path With roots in insurance, Ameriprise has transformed itself into a financial powerhouse, with more than $800 billion in assets under management and over 9,700 agents at 2014 year-end. The firm continues to shift away from insurance and place more emphasis on financial planning and wealth management operations. The 2010 acquisition of Columbia Management turned Ameriprise into a contender in the U.S. fund management business. Today, insurance and asset management are equal contributors to earnings. We believe this transition could help Ameriprise set itself apart from many of its peers, with its balanced business mix providing it with the best of both worlds--high returns and low capital requirements in the asset management business and stable cash flows from its insurance operations.

Ameriprise's two-prong business model is not unique in the industry, though, as a number of other industry players have made inroads into fund management. We think this trend is likely to continue, as traditional insurance companies look for ways to generate recurring fee income and reduce capital requirements in a low-interest-rate environment. In the case of Ameriprise's acquisition of Columbia, we think the firm has been able to leverage the brand name, making itself a full-service brokerage platform that offers more than 3,500 mutual funds.

Sensitivity to Capital Markets Brings Risk Financial markets and economic conditions can have a significant impact on the operating results of Ameriprise's insurance and asset management segments. Market volatility, as well as prolonged declines in asset values, can have a negative impact on flows in the asset management business, as well as sales of annuities and insurance products. Persistent low interest rates have also put pressure on earnings, especially on the insurance side. Despite these challenges, Ameriprise remains steadfast in its strategy to expand its asset management operations, potentially through another acquisition. While the company's balance sheet is not as leveraged as some of the larger insurers', we still think an investment in Ameriprise carries a high level of uncertainty, given how sensitive its business is to the capital markets. Shareholders' equity can be stressed in times of substantial market volatility when investments are marked to distressed prices. Additionally, on the asset management side, net asset flows are highly sensitive to fund performance and investors' sentiment toward capital markets. Fee income in the asset management business can be adversely affected in declining markets.

More M&A Not Out of the Question From a capital-allocation perspective, Ameriprise typically returns the majority of excess cash to shareholders in the form of stock repurchases and dividends. In fiscal 2014, the company returned nearly $1.8 billion to shareholders, composed of $1.4 billion in share buybacks and $435 million in dividends. The levels are largely in line with the company's past practices. As far as acquisitions are concerned, the firm has not been that active in the market following the Columbia deal, preferring to focus on integrating the many parts of businesses of different cultures and leaderships into one seamless and profitable platform. While this does not rule out another acquisition, we think the target company would have to offer a compelling value proposition to the existing fund management or insurance businesses for Ameriprise to bite.

In our view, chairman and CEO James Cracchiolo is a competent executive and his management team has shown the ability to put together a series of high-profile acquisitions. As Ameriprise continues its transition from a life insurer to an asset manager, we expect the company to face fierce competition from more established asset managers while defending its market share in the insurance business. When that happens, it might make sense for Ameriprise to consider putting the insurance business up for sale, in our opinion.