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Stock Strategist

Industry Fundamentals Doom Citigroup Spin-Off

Primerica's marketing structure is not our only concern.

Mentioned:

 Citigroup (C) plans to spin off insurer Primerica in an IPO set for the week of March 29. The deal will consist of 18 million shares with an offer range of $12-$14 per share, for a total in the range of $234 million. Morningstar senior analyst Jim Ryan is not impressed with the firm's business model and believes it operates in an industry with poor overall fundamentals. Here is Jim's take on Primerica:

"Primerica is a multitier marketing organization that sells term life insurance and other financial products to middle-income consumers. The firm also sells mutual funds, variable annuities, segregated funds, and other financial products. Primerica boasts that it markets its products through 125,000 independent contractors who manage their own businesses and pay the administrative overhead. Primerica is structured so that any new sales representative shares commissions with the person who recruited him or her. Further, the new recruit is encouraged to recruit new sales representatives, which it is hoped will generate commissions to be shared up the chain of command.

"We think the marketing structure of Primerica, which the company touts as its greatest strength, is actually a major weakness. Primerica relies heavily on recruiting sales representatives to provide new referrals, a strategy that is difficult to sustain. In fact, even though the company has recruited north of 200,000 bodies over the each of the past five years, the number of licensed insurance and mutual fund representatives has remained flat at about 125,000 per year, indicating an extremely high fallout rate. The average sales representative sells only two and a half new policies per year, a paltry amount by any measure, and we think marketing through independent representatives cedes all control of the customer to salespeople who can easily switch to another company. Finally, various laws and regulations forbid fraudulent or deceptive practices known as pyramid schemes. The company notes in its filing that if federal or state regulators change their interpretation of applicable laws to prohibit Primerica's structure, the company could be damaged irreparably.

"Primerica's marketing structure is not our only concern. We believe most life insurance companies do not have an economic moat because of poor industry fundamentals. Term insurance is price-sensitive and available from multiple sources, including the Internet. What's more, most life insurers bear credit market risks that can severely affect shareholders' equity, as was demonstrated over the past year. Because of a lack of underwriting profitability, life insurers have a tendency to stretch for investment income, leading to risk-assumptive investments.

"As part of the offering, Primerica will enter into co-insurance agreements with Citicorp, which will cede the risks and rewards of the majority of existing term life insurance policies as of the end of 2009. After the spin-off, Primerica intends to retain the premium and policy liability on all new business written.

"All things considered, we'd recommend avoiding this IPO."

This report is made available compliments of Morningstar IPO Research Services. For more information on Morningstar IPO Research, please contact Marc DeMoss at marc.demoss@morningstar.com or +1 312 384-4052.

Bill Buhr does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.