Riders On The Storm: Healthy Dividends In Mid-Cap Insurance

 |  Includes: MCY, OB, SAFT
by: ValueArtifex

"Oh the weather outside is frightful..."

2012 was a rough year for many insurance businesses, particularly for companies with a geographic concentration of policies on the East Coast of the United States. Severe weather, including Superstorm Sandy caused a large amount of catastrophe-related losses. The situation in 2013 remains to be seen, however the recent snowstorm on the east coast provides an ominous portent for the future.

Despite the higher-than-average claim payouts affecting profitability, this type of scenario can furnish investors with considerable opportunities if they are willing to ride out the storm in the near term. I will be discussing three insurance companies that have been or have the potential to be impacted by weather-related losses. I also believe these companies offer significant value to an investor who has the fortitude to focus on the long term and buy into the news of short-term losses.

One Beacon Insurance

The first insurance company I have been following is One Beacon Insurance (NYSE:OB). One Beacon is a property and casualty insurer that focuses on a wide variety of specialized lines of business. One Beacon offers a range of insurance products including marine, collectible cars, tuition refund, professional liability, entertainment, technology and more. Currently priced at $13.88 and offering a dividend rate of over 6% against a book value of $10.63 and cash per share of $2.93, I believe that the company offers an investor a good value at current price levels. Despite having recorded a combined ratio consistently below 100%, OB's combined ratio for the fourth quarter of 2012 was 111% compared with 85% in 2011 - reflecting the large amount of weather-related disaster. The company is exposed to significant weather related risk through its International Marine Underwriters unit.

The reason I like One Beacon Insurance is because of the fact that it caters to specialized products or situations. Tuition Insurance and insurance of collectible vehicles or boats are especially interesting lines of business to me for a variety of reasons. If one purchases insurance for a prized possession, it is clearly evident that the individual values the possession highly and will treat it with a heightened standard of responsibility or care in order to protect it against damage or destruction. Though insuring an object such as a boat or a collectible car might allow the policy holder to recoup the replacement value - the unquantifiable sentimental value of a special or otherwise rare object would cause the policy holder to treat the property with heightened sense of care, which would translate into fewer claims paid out.

Tuition insurance is also a similar situation. As costs for education rise, both children attending school and parents are increasingly aware of the value of staying in school and working hard. Tuition insurance policies primarily protect against physical injury or medical ailments and exclude students withdrawing because of poor academic performance and drug or alcohol abuse - reducing the total risk considerably. Voluntary purchasers of tuition insurance, like those who purchase insurance on collectibles are also typically self selecting, which could translate into an already risk-averse pool of policyholders.

Mercury General Corporation

Despite conducting a majority of its business in California, Mercury General (NYSE:MCY) has expanded throughout the United States and specializes in offering various types of automobile insurance with secondary offerings including homeowner, fire and property insurance. Mercury has consistently increased its dividend for well over a decade, and currently has an annual yield of 6.78%, with a book value per share of $33.55 and a market capitalization a little north of $2 billion against a price of $36.14. Despite suffering losses this year, the company has sought to consolidate its business outside of California into regional hubs in order to increase savings through operational efficiency, a move which could generate significant value for shareholders in the future.

Despite the promising qualities of this business, it is important to note that there is a very real risk of Mercury being severely impacted by an earthquake disaster in California, and investors should be wary. I believe that Mercury General has the potential to turn into a very attractive purchase when an earthquake does occur in California. The nature of the insurance industry is to suffer massive, one-off losses when the inevitable happens and investors should be fully aware of this fact. Were a large earthquake to strike California, particularly Southern California (due to the large population of people who regularly use automobiles relative to the northern parts of the state), investors could be presented with a significant opportunity to purchase Mercury shares at a considerable discount.

Safety Insurance Group

The smallest of the bunch, with a market capitalization of $735 Million, Safety Insurance (NASDAQ:SAFT) is a very promising company. Though focusing on private automobile insurance in the Massachusetts area, Safety has recently expanded into New Hampshire. The company also offers other lines of insurance including homeowners, fire, and commercial vehicles. Currently priced at $46.76 per share against a book value of $45 and yielding 5.1%, the company has consistently increased dividends with a current payout ratio of 60% and zero debt. Depending on the severity of the recent snowstorm, Safety could be facing near-term losses as a result of its exposure to a small geographic region impacted by this weather event. Despite this risk, I believe that a buying opportunity could present itself for a careful and patient investor.

Since going public in 2002, the company has grown at an impressive rate. I believe that if Safety is successful in expanding its operations into New Hampshire and can capture a significant part of the auto-insurance market in the region, there will be reason for both dividend increases and considerable share appreciation on the horizon. I also think that over time the company has real potential to expand throughout the New England region. If Safety's underwriting team is experienced with the weather and other hazards in the Massachusetts and New Hampshire region - I believe that it would take minimal effort to expand into other parts of New England, which experience very similar conditions over the long term.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in OB, SAFT, MCY over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.