When screening for those companies beating industry averages of ratios such as price to earnings (P/E), return on equity (ROE), price-to-book and profit margin, a dozen property and casualty insurance companies emerge. Normally, beating industry averages can be a discerning method for comparing companies. However, appraising insurance companies calls for additional criteria. Income, expenses, cash and debt are all analyzed with a twist.
Paring the list of industry-average-beaters to include only those expected to grow revenue and earnings per share (EPS) in the next year leaves only Allied World Assurance Company (AWH), Montpelier Re Holdings (MRH) and Everest Re Group Ltd (RE). The three are then compared to American International Group (AIG), the industry's large cap industry-average beater.
Recent High Last Week
Combined Ratio (mrq)
*Information is 3Q12 data; Montpelier reports 4Q12 information 2/7/13
Income is earned two ways by insurance companies. The first is from customers paying premiums for coverage and the ability to file claims. The second is from returns on its investment portfolio that a company holds to be able to service claims. Cash that is not reinvested, distributed to shareholders through dividends or used for share buybacks, but is rather just accumulating, is not considered a favorable asset for insurance companies.
Debt also takes on a slightly different meaning. Debt is to an insurance company as raw materials are to manufacturing firms. Debt obligations are what an insurance company uses to create opportunity, build its portfolio and yield profit. Carrying as much debt as the company can afford to carry, whether it be by risk or regulation, makes it very likely the firm is valued fairly.
Therefore, opposite the majority of businesses, an insurance company sitting on tons of cash with no debt is not a successful operator. Because determining fair value is so difficult, ratings agencies exist for the insurance industry. A.M. Best, Standard & Poor's, Moody's Investors Service, and Fitch Ratings are the most prominent rating companies. A.M. Best ratings are based on financial conditions and performance while the other three are based on claims-paying ability.
The book value per share and shareholder return metrics are emphasized when evaluating performance for an insurance company. Most insurance companies strive to maximize book value per share with each successive year and to achieve a compound annual growth rate (CAGR) in double digits for shareholder return. Shareholder return is calculated by adding book value to the annual dividend.
For comparison to its peers, the insurance industry uses the combined ratio. The combined ratio adds claims and expenses and then divides that sum by premiums earned. When the company is bringing in more premiums than it is paying out for expenses and claims, it is considered efficient. The lower the fraction, the more efficient it is. Quotients over one indicate inefficiency. The combined ratio is not an indication of profitability, however, since the company also generates revenue from its investment portfolio.
Somewhat oddly, news of catastrophic events can actually be viewed as opportunity for property and casualty insurers. Short-term, the companies are impacted by obligations for pay-outs on claims. However, long-term, the group is able to raise premiums and generate more recurring revenue. 2011 was the costliest catastrophe year on record for many property and casualty insurers due to Australian floods, New Zealand's earthquake, Japan's earthquake and tsunami, Thailand floods, U.S. storms and Hurricane Irene. For 2012, catastrophes were tracking significantly less with U.S. storms, Hurricane Isaac, drought and crop losses until Hurricane Sandy hit in October.
Another consideration for viewing the insurance business is the concept of reinsurance. Even insurance companies need insurance. Firms use reinsurance to reduce risk by transferring potential claim obligations in exchange for portions of the original premium received. Reinsurance provides competitive advantages because there is more control over pricing and it is easier to exit poorly performing business.
American International Group operates in over 130 countries. Besides property and casualty insurance, AIG offers life insurance and retirement services. AIG's recent history includes the receipt of $182.3 billion of support to meet its financial obligations from the U.S. Government in 2008. By December, 2012, the full $182.3 billion had been recovered along with a return of $22.7 billion and the Treasury's ownership stake in AIG was eliminated. AIG discontinued its dividend throughout this period. AIG's estimated five-year EPS growth is 21.9%.
Allied World Assurance Company Holdings operates in Bermuda, Europe, Hong Kong, Singapore and the United States. Allied World's book is 33% reinsurance. Allied offers a diversity of products including 27% property and 28% casualty. Analysts' five-year growth estimate for EPS is 13.4%. Allied has an active share repurchase program currently authorized at $467 million. Allied pays a dividend of $1.50 annually for a yield of 1.8%.
Montpelier RE Holdings provides reinsurance and insurance through segments in Bermuda, the United Kingdom and the United States. Montpelier's book is comprised of 74% reinsurance products, 30% of which are international and 70% are U.S. based. Of Montpelier's product mix, 50% are property-related. Montpelier's true focus is short-tail reinsurance which refers to the lapse of time between claim and settlement. The five-year growth estimate from analysts for Montpelier is 12%. In July, 2012, Montpelier increased its share repurchase authorization by $250 million. Montpelier pays a dividend of $0.46 annually for a yield of 1.9%.
Everest underwrites reinsurance and insurance in the United States, Bermuda, and international markets. Everest is the former reinsurance arm of The Prudential. For Everest, 77% of its book is reinsurance and 57% of the reinsurance book is non-U.S business. Everest's exposure is 64% property and 36% casualty. The five-year EPS growth estimate is 12.5%. The current share repurchase authorization at year-end 2012 for Everest is 4 million shares. The yield is 1.6% for a dividend of $1.92.
In 2008, AIG's share price fell over 95%. In just the last year, AIG's share price increased 42%, a step ahead of Allied World's 32%, Montpelier's 35% and Everest's 33% gains. As shown in the table above, AIG is still 76% below its book value. Allied World is 13% under while Montpelier and Everest are 11% under. All four companies are within 2% of their 52-week high and appear positioned to maintain the upward momentum.
AIG even appears poised to continue its above-average bounce. Recent headlines in the Wall Street Journal even hint at AIG's risky risk appetite. So, if the mere mention of AIG still registers too high on an investor's risk meter, Allied World Assurance Company, Montpelier Re Holdings and Everest Re Group Ltd could be options with premium potential yet reduced risk.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.