By Carla Pasternak
They're the creme de la creme of the income universe.
Each one has increased its dividend every year for at least two decades... some sport track records with more than 50 years of consecutive dividend increases.
All told, these stocks are some of the most reliable dividend payers on the planet.
I'm talking about the S&P 500 "Dividend Aristocrats" and their kissing cousins, the S&P "High-Yield Dividend Aristocrats."
To become a member of these elite groups, a company must pay a regular dividend, but it must also enjoy a stellar track record of growing that dividend every year for at least 20 years.
With such stringent membership criteria, only about 70 U.S. companies make the grade.
As you'd expect, a wide variety of industries are represented. You'll find an overweighting of consumer staples such as Procter and Gamble (NYSE: PG) and Kimberley Clark (NYSE: KMB), and a healthy chunk of electrical utilities, such as Consolidated Edison (NYSE: ED) and Northwest Natural Gas (NYSE: NWN).
But there's one group that makes the list that you would probably never expect: insurance.
All together, six of some 70 aristocrats sell insurance. Even more interesting, five of these six companies are property and casualty insurers. The exception is Aflac, which is mainly a life insurer.
What is it about property and casualty insurers that allow them to keep increasing their dividends in good times and bad for at least a quarter of a century?
The answer surprised me. Here's what I found out...
Today, insurance is usually life or non-life, also known as property and casualty.
Property insurance covers loss or damage to physical property, such as houses and cars. Casualty insurance covers the legal cost if the insured person were to cause someone else physical injury or damage another's property. Liability insurance is a common example.
You might expect property and casualty insurers such as Dividend Aristocrat -- RLI (NYSE: RLI) -- to be cash-flow machines... churning out streams of highly predictable earnings quarter after quarter.
Nothing is further from the truth.
Their earnings streams are notoriously volatile. Major unpredictable risks, such as natural disasters, have a huge effect on earnings.
So why do I like property and casualty companies then? As in all industries, some companies far outperform others. RLI is one of them -- as measured by the combined ratio, the key industry metric of underwriting profit.
The combined ratio combines two metrics. It measures underwriting expenses as well as the amount paid out in claims, both as a percentage of net premiums earned.
A combined ratio of 100 means the company is breaking even on its underwriting activities; the lower the ratio, the higher the company's underwriting profit.
In 2011, RLI's combine ratio was an outstanding 78.4... Well below the industry average of 107. During third-quarter 2012, RLI's combined ratio was 87.7 -- ticking up because of damage caused by Hurricane Sandy.
RLI has seen 16 straight years of underwriting profitability, with an average combined ratio of 87 during the period.
And while property and casualty companies may break even or lose money on their underwriting activities... that is only part of their financial story.
These companies accumulate millions and even billions of dollars of investment capital, which provides investment income that makes a vital contribution to their per-share earnings.
For example, RLI earns investment income and realizes gains from a $1.9 billion portfolio, comprised 74% of high-quality debt with an average "AA" credit rating, and 26% in equity.
Given the investment portfolio comprises the lion's share of earnings, management's decision on whether realize capital gains or losses by selling investments can cause tremendous earnings volatility from year to year.
How can volatile earnings grow dividends?
First, insurance companies keep their payout ratio relatively low, so it can inch up the dividend regardless of earnings. RLI had a payout ratio of 25.0% of in 2009, 19.2% in 2010 and 19.5% in 2011.
Meanwhile, insurance companies keep building shareholders' equity, which they can dip into on a temporary basis to supplement the dividend if there were a short-term earnings shortfall.
That's one reason RLI has been able to pay a dividend for 146 consecutive quarters and raise its ordinary dividends for 38 consecutive years.
For the past three years, the insurer has also returned excess earnings to shareowners in the form of one-time special dividends. In 2010, the special December payout was $7 a share and in 2011 and 2012, it was $5 a share.
During the last four quarters, the company paid out $1.26 in ordinary dividends. Factoring in last year's special dividend, shares of RLI provide a remarkable yield of 9.2% at today's price -- an outstanding yield for a member of the "Dividend Aristocrats."
That also makes it the highest-yielding "Dividend Aristocrat."
Risks to Consider: If management decides to break with its three-year policy of paying out a special dividend from excess capital, the stock would no longer be suitable as a high-yield income play.
With that said, many insurance companies have a surprisingly good track records when it comes to dividend payouts. If you're looking for a high-yield stock with a reliable dividend, then an insurer like RLI may be suitable for you.