In January 2013, I contributed an article on the value I had detected in the insurance industry. A majority of the insurance companies I analyzed seemed to be undervalued historically and compared to the market. As a follow up I wanted to revisit the thesis of my article to examine the past year and see where insurance company values stand today.
As of December 20th, 2013 the insurance companies researched and recommended in the article we up a combined 79%. The past year was fantastic for almost every company and the S&P 500 was up a combined 31%. The 79% return was more than double the 2013 return off the S&P 500. The article was called The Life Insurance Industry is Ripe for the Picking and the article detailed insurance companies that I found were trading at significant discounts to their discounted cash flow value and their book values.
I still see upside in three of the above referenced companies. The companies that I believe still have the prospect to reach their true value are Hartford, Aegon, and AIG. These companies are still trading at a significant discount to their book value. Aflac's price has exceeded its book value but it still trades at a discount to its discounted cash flow value. Let's take a look at the business prospects for the three insurance companies that I think are still a good value.
Hartford Financial has had a remarkable 2013 and I still see upside for this company. Hartford has aggressively increased the quality of its underwriting performance through better pricing and underwriting requirements. Earnings are expected to increase 14% per year for the next 5 years which should lead to earnings almost doubling by 2018. This should jump earnings from $3.65 in 2013 to $6 per share by 2018. Hartford has been dramatically improving profitability by focusing on cost cutting and improved underwriting margins. Hartford's underwriting combined ratio improved this quarter from 96.3 to 93.8. Hartford has also completed a deal to market its auto and homeowners insurance to AARP member s through 2023 which should solidify its business in this segment.
Aegon's business prospects remain solid as the company has increased revenue through strong life insurance sales and increased variable annuity sales in the United States. Aegon has been performing very well in the US as the company has increased the retail value of retirement products. Additionally, Aegon has inked some major new distribution deals with Edward Jones, Mercer, and Banco Santander. All told these new distribution channels will put Aegon in 18,000 new brokers and banks branches in the US, UK, and Spain. Aegon, like all of the insurance companies I am profiling, would benefit from increasing interest rates as this would allow the company to increase the revenue it receives from treasuries and guaranteed investments. One point of caution for this company is its large exposure to Europe. Should the European economy reverse its recovery it could drag down Aegon's performance.
AIG has made a dramatic comeback from the depths of the great recession. AIG has been strengthening its capital position by disposing of unrelated assets and AIG has disposed of its toxic contracts that got the company in trouble back in 2008. AIG's total debt burden has been reduced to $42 billion and its market capital is $71 billion. AIG's future business prospects look bright as earnings are expected to rise by 7-8% in 2014. I believe that AIG's value proposition is too large to ignore at this point and the company has significant upside.
Last year was good to many companies and industries. I luckily discovered that several insurance companies were undervalued and in the value investment range. The thing that struck me was that the insurance industry as a whole was trading at a discount. The most obvious items that struck me were that many insurance companies were trading at significant discounts to their discounted cash flow and their book values. These companies weren't value traps and many had bright prospects and were suffering mainly from carry over problems remaining from the financial crisis and perception problems in the eyes of many people in the investment community. I will continue to search out value situations and share any discoveries where an investor has a significant chance of upside with limited downside potential.
Disclosure: I am long AIG, HIG, . 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.