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Value investors are always interested when a stock trades under book value, particularly when there is a viable business activity with actual earnings. For the past year or more, many insurance companies have traded at discounts to book, sometimes quite steep. This article explores insurance company P/B relationships, finding that some of them are indeed bargains on that basis, while others may be value traps.

Background

Insurance companies typically publish a quarterly financial supplement in connection with their earnings, providing detail above and beyond what is available in the press release and basic financial statements. Most of them include one or more alternatives to GAAP book value, typically a book value excluding accumulated other comprehensive earnings (BV exAOCI), sometimes described as an adjusted book value. The nonGAAP book values provide some insight into mark to market issues, as the largest difference is that they reflect amortized values for fixed income investments.

Investing on the basis that GAAP book values would revert toward nonGAAP as the markets recovered, with a similar increase in share prices, has been profitable. However, none of the insurance stocks I follow has recovered to where share prices are much more than book. Before the crisis, a P/B of 1.2 to 1.4 was more typical, raising the question if or when these companies will again trade at a premium to book value.

What the Charts Say

These issues can be illustrated quite clearly by graphing book values against share prices. The first two are life insurers Prudential (PRU) and MetLife (MET). The remaining three are P&C companies – Chubb (CB), Travelers (TRV) and Allstate (ALL).

click to enlarge images

Two Life Insurers

MET and PRU exhibit broadly similar patterns. Before the crisis, both traded at a P/B well in excess of 1. As the situation developed, book values came under extreme pressure, with mark to market driving GAAP values well under BV exAOCI. In addition to questions about RMBS and CMBS assets, there were questions about CRE and guarantees on variable annuities, the effectiveness of hedges and the need to de-risk portfolios, realizing losses in the process.

In recovery, GAAP book value have reverted to levels similar to BV exAOCI, suggesting that worries occasioned by mark to market accounting were excessive, and could have been greatly reduced by using amortized values. In any event, investing on that basis was profitable for these two cases. Both have been reporting good earnings, and there is every reason to look for share prices to get up into the area of 1.2 X Book. PRU looks better than MET for the fact there was no permanent loss of book value during the downturn.

Three P&C Insurers

Chubb and Travelers exhibit broadly similar patterns. Both companies have conservative investment strategies, resulting in a fairly steady upward march of book values, if not of share prices. Bonds are of higher quality, and have appreciated rapidly during the flight to safety.

These are stocks that are very comforting to the value investor, as at the end of any substantial period of time he can verify that his shares represent a claim on an increasing store of assets. It is puzzling why they don't attract more investor attention. If something is going to be worth 10% more at the end of any given year, there should be some premium to the price of it.

Judging by the development of book values, these two companies motored through the financial crisis with very little difficulty. However, P/B multiples remain under compression. That could change.

Allstate is another story. Here book values plunged, dragging share prices with them, but have not recovered to anything like the previous level. There has been a definite destruction of value here. Investment strategy was too aggressive, chasing yield in RMBS and CMBS. Ultimately it became necessary to de-risk the portfolio, incurring substantial losses. The most recent quarter featured good investment results, seriously diminished by hedging losses - risk reduction hurting profits – whipsawed.

It is understandable that the company is trading for less than book value. After all, there has been a history of value destruction, and it is by no means certain that the process has reached an end. Why pay full price for something that may be worth 10% less at the end of the year? On the other hand, the most recent earnings conference call featured a management that seems to have an understanding of what they have been doing wrong, and a plan for corrective action.

Investment Implications

GAAP book value is an unstable metric, particularly for financial companies that use aggressive investment strategies. Various nonGAAP book values are more stable and better reflected true values during the meltdown. In times of financial stress investors may be able to secure excellent returns by developing and applying an understanding of the asset valuation issues highlighted by these differences.

There is a potentially messy complication. Companies that are forced sellers either due to liquidity or de-risking concerns, such as pressure from rating agencies, can suffer rapid and permanent loss of value. At the bottom, there is always the fear that things could get worse, creating pressure to realize losses rather than hold through to recovery.

Book value cannot be used in isolation as an investment criterion. Investors should consider the risks and growth potential associated with the company's operations, as well as the quality of assets, the accuracy of estimated liabilities, and the investment philosophy employed. Under stable economic conditions and average levels of investor confidence insurance companies trade at a premium to tangible book value.

Some Average Multiples

Here is a table, with current prices, P/B multiples, and 5 year average multiples:

Symbol

Share Price

P/B

5 Yr Avg P/B

ALL

28.98

0.9

1.5

CB

53.76

1.1

1.4

MET

41.42

0.9

1.2

PRU

59.08

1.0

1.4

TRV

50.27

0.9

1.2

Disclosure: Author is long ALL, CB, MET, PRU and TRV

Source: Insurance Companies: Attractive Based on Price to Book