One of Warren Buffett's most well known investments is GEICO. GEICO was successful for several reasons - it provides direct insurance policies by mail to reduce costs and it also chose its customers carefully. At least initially, GEICO targeted a specific group of customers under the assumption that they would be, as a group, inherently less risky to insure. What group is this do you ask? All you have to do is pick apart the GEICO acronym: Government Employees Insurance Company. The early business rested under the premise that if you work for the government and depend upon it for your income, logic dictates you are more likely to abide by its laws (especially when driving) in turn producing less insurance risk and qualifying for a lower rate.
A Similar Situation?
Despite utilizing agents to conduct their business, I believe that Horace Mann Educators Corporation (HMN) exhibits some qualitative similarities to the advantages that GEICO enjoyed in its early years. Horace Mann is currently trading at $21.75 against a book value of $31 and cash per share of $5 with a P/E of 8.5. The company also pays a dividend, currently just under 3% and has increased its dividend to levels that now exceed those issued during the years prior to the most recent financial crisis.
Horace Mann writes home, auto, disability and life insurance in addition to providing college savings plans for educators and their families. The company has also been involved in the annuity business since 1961, taking advantage of provisions adopted through the IRS tax code which allow employees of public and other non-for profit schools to reduce their pre-tax income via retirement contributions.
The company is a small one, with a market capitalization around $850 million. Despite its small size, I believe that the company has the potential to be an excellent investment because of virtues exhibited by the clientele it serves. In a similar vein to the government employees covered by GEICO, I believe that teachers are a naturally advantageous group to insure for several reasons.
1. In the United States teachers engaged in public education must obtain a teaching credential in addition to a degree from a university or college. Teaching credentials can be revoked for numerous criminal offenses and it would be a sensible assumption to assume that a majority of the pool of insured educators are aware of such a fact and make a conscious effort to abide by laws and regulations in a manner similar to the early clients of GEICO, who were more likely to abide by laws by virtue of their employment.
2. Teachers in many states must also be fingerprinted and have criminal background checks before they are allowed to work with children. Both of these measures help to mitigate the inclusion of individuals predisposed to bad behavior, reducing the aggregate risk of the population covered by the insurance company.
3. Job Security and Tenure - In many parts of the United States, teachers have strong union representation, tenure and benefits. The presence of job security and benefits spread throughout a profession reduces insurance risk in my mind, which compared against a conventional pool of insured persons in a specific geographic area. I believe that if a pool of insured individuals is relatively similar in regards to occupation, income and healthcare standards, insurance risk is more easily quantified, translating into more competitive premiums and profits.
Location, Location, Location...
According to its 10-K, which can be found here, Horace Mann generated 57% of its Property and Casualty revenues from 10 states, with California as the largest single source of revenue, accounting for nearly 10%. North Carolina, Texas, Minnesota and Florida round out the top 5 states for direct premium sources. Though the company has spread itself throughout America, considerable risk to property and life through catastrophic natural disasters exists in many of these regions through hurricanes or earthquakes, which could cause a drop in profits.
What About the Combined Ratio?
The Combined Ratio is a useful method to evaluate insurance companies. A number below 100 indicates that the insurer is producing a profit from its underwriting operations. A number in excess of 100 indicates that the company is paying out more dollars in claims than it takes in through premiums, reducing the size of the all important float.
Though the combined ratio is useful, one must also remember that the float (the money generated by premiums not spent on expenses or claims) is invested, typically into fixed income or equities, to produce profit for the reinsurer.
Horace Mann had a combined ratio for 2011, 2010 and 2009 of 106.7%, 100.9%, 99.5% respectively. The high number for 2011 reflects a large percentage of catastrophic losses - i.e. those caused by natural disasters, which accounted for 15.7% of the combined ratio for that year. From these metrics, it is apparent that HMN has not been able to produce profits from underwriting, and has been almost fully reliant upon the investment of float to generate profits in the past several years.
A majority of HMN's float is invested in fixed income, including federal, state and municipal bonds in addition to public utility bonds, with minority equity investments largely in non-redeemable preferred securities.
A catalyst for purchase (or adding more to a position) could be a large natural disaster, which could trigger a brief decline in the company's price because of the large amount of potential claims which could create an earnings miss. I believe that the company is a solid one operating in a niche business, retaining advantages that could make a good candidate for further investment research.