Chubb Corporation (CB) just capped off a good year with a fine 4th quarter, eliciting indifference from the markets.
Shares are currently trading in the neighborhood of 50, at a P/B of 1.1 and a TTM P/E of 9.4. Property and casualty insurance companies are not getting any respect.
Chubb, best of breed, has been written up favorably by Barron's and still can't attract any attention. Perhaps fear of credit crisis claims in its Professional Liability business is depressing share prices.
The Value Creation Proposition – As an investor, it can be very comforting to be able to point to a steadily increasing book value. It is reassuring to look past the quarterly ups and downs, the vagaries of mark to market and GAAP accounting, and focus instead on the long term progress of your metric.
CB's tangible book value per share has increased 10.5% per year for the past ten years, and 12.1% for the past five. Meanwhile, the company has paid a dividend, currently yielding 2.82%. This is a fabulous accomplishment when set against the lost decade of the S&P 500.
Over the past 7 years CB's midpoint price/tangible book ratio is 1.32. Projecting tangible book value to reach 47.50 by the end of this year, and applying a 1.32 multiple, I develop a midpoint price target of 63 per share, a 26% increase from today's price.
Except for 2009, CB has traded above a multiple of 1.5 at some point during every year for the past 10. That would be 70 if book value develops along the lines projected.
Asset Quality - Like most insurance companies, Chubb publishes two book values – GAAP and nonGAAP. Chuub's nonGAAP metric is book value with available-for-sale fixed maturities at amortized cost, 44.37 as of 12/31/2009. GAAP Book value came in at 47.09. Mark to market cuts both ways. The quality of Chubb's assets is not an issue.
Ample Capital – A common ratio used to asses the capital adequacy of property and casualty insurance companies is premium/surplus. Years ago, 2 was pretty much the norm, as long as a company stayed under that it was OK. The most recent conference call featured a question on Chubb's premium to surplus, in which an analyst questioned whether with a ratio of .76 the company might not want to consider doing something with the excess capital.
Management is not really interested in doing acquisitions. Chubb employs skilled underwriters and is known for a sound and conservative approach to the business. My guess is that management doesn't want to get into a lot of culture clash trying to integrate a company run on another basis.
Chubb has a history of buying back shares and can be expected to continue that practice. At today's prices that activity will reliably increase shareholder value. There is also a dividend, 2.82% at today's price.
Operations – From the 10-K:
Chubb is a holding company for a family of property and casualty insurance companies known informally as the Chubb Group of Insurance Companies (the P&C Group). Since 1882, the P&C Group has provided property and casualty insurance to businesses and individuals around the world. According to A.M. Best, the P&C Group is the 11th largest U.S. property and casualty insurance group based on 2007 net written premiums.
The P&C Group is divided into three strategic business units. Chubb Commercial Insurance offers a full range of commercial insurance products, including coverage for multiple peril, casualty, workers’ compensation and property and marine. Chubb Commercial Insurance is known for writing niche business, where our expertise can add value for our agents, brokers and policyholders. Chubb Specialty Insurance offers a wide variety of specialized professional liability products for privately and publicly owned companies, financial institutions, professional firms and healthcare organizations. Chubb Specialty Insurance also includes our surety business. Chubb Personal Insurance offers products for individuals with fine homes and possessions who require more coverage choices and higher limits than standard insurance policies.
Over the past ten years Chubb has been involved in some difficult insurance situations, such as Katrina, asbestos liability and toxic waste. Based on long term results management has handled these challenges well.
Credit Crisis D&O and E&O – As a large writer of D&O (Directors and Officer's Liability) and E&O (Errors and Omissions), Chubb has faced claims arising from the credit crisis. The question here would be whether the company has adequately reserved for the losses in question. The most recent conference call includes a fairly long discussion of the topic. After reading it, I lean toward the view that management has a good handle on the issues and that the reserves reported are accurate.
Back when the backdating of employee stock options was an issue, there were similar discussions and concerns. The company's views on their ultimate losses proved accurate, establishing credibility as far as I'm concerned.
Operational vs. Investment Risk – From the foregoing it is evident that Chubb writes some lines of business that other carriers find difficult. Set off against that, the extremely conservative asset quality and the generous if not excessive capital devoted to the business provide stability and the ability to handle underwriting or loss difficulties as they arise.
If a line of business experiences above average losses, prices increase until there are excellent profits available. To take advantage of such situations, capital is required, not always easy if recent results have been unsatisfactory. Chubb's strong balance sheet will be an asset the next time this situation develops.
Summary – Over a period of time Chubb has developed strengths in high end personal lines, niche commercial, and professional liability insurance, backed by underwriting expertise and an agency plant that understands and serves the types of business and policyholders involved. Some competitors, such as AIG, have experienced financial stress, while Chubb is well capitalized. Insurance is a competitive business: however, Chubb is an extremely capable competitor.
Strategy – Suitable for the dividend or buy and hold investor: a right size position would a good addition to any portfolio focused on that type of investment. Today's prices are attractive.
For investors who use options, Chubb's relatively low implied volatility and dividend create a situations where in the money LEAPS are moderately priced and can be used to provide a combination of leverage and clearly defined downside exposure. The sale of some shorter term out of the money calls, along the lines of the covered call strategy, can be considered in order to generate some income and provide a little bit of a hedge against a price decline.
Disclosure: Author is long CB options, as described