Nationwide Mutual and Harleysville Mutual have agreed to a merger, with Nationwide acquiring the publicly owned shares of Harleysville Group (HGIC) for 60.00 a share, a 90% premium to yesterday's close. HGIC traded as high as 58.75 on the news, sparking a small rally in insurance shares. What does the agreed price say about insurance company valuations?
The price amounts to 2.1 X tangible book, or a TTM P/E of 34. With a quality P&C company like Travelers (TRV) selling for 1 X tangible book, and a TTM P/E of 9.4, there's a big discrepancy in valuation.
Mutual vs. Stock Insurance Companies
Mutual insurance companies are owned by their policyholders. As such, when Nationwide Mutual and Harleysville Mutual merge, Harleysville's policyholders will become Nationwide policyholders (and owners).
HGIC is a stock insurance company, originally wholly owned by its mutual parent. Over the years, 54% of the shares outstanding were sold to investors. HGIC's subsidiaries participate in a pooling arrangement with the mutual company, reinsuring all their business with the parent.
When I started in the insurance business, I worked for Kemper, a collection of mutual companies, which also had a stock company sister, owned by Kemper management. The stock company wrote business on its own, but also was paid a fee for providing underwriting and claims services to the mutual companies. Basically it was a way for management to monetize its control of the mutual companies.
Other advantages included the ability to use stock company rates instead of mutual rates, at a time when rates were set by rating bureaus and there was little competition. Stock companies could file deviations, giving the customer a price reduction up front, instead of making him wait for a dividend.
Because of the possibilities involved in the relationship with the mutual company, I would be a little wary about attributing the valuations from the HGIC deal to insurance companies as a group.
Harleysville Compared to Peers
Over the past ten years, HGIC averaged a combined loss and expense ratio of 103.5%. While the company generally made a profit, based on investment income, it is not good practice to run a combined ratio greater than 100. Travelers, in contrast, averaged 98.1% for the same period, with recent years averaging about 90%.
Over the same period, HGIC increased tangible book 3.7% per year, compared to 21% for Travelers. Comparisons to Chubb (CB) would be equally unflattering.
I would characterize Harleysville Group as a mediocre insurance company.
Implications for Industry Valuations
This doesn't mean insurance companies will trade at 2X tangible book anytime soon. Kemper, formerly called Unitrin (UTR), which I wrote up earlier this year, and traded profitably with options, is trading at a P/B of 0.68 today, and a TTM P/E of 9.75. Kemper is somewhat comparable, being small enough to make a nice fold-in acquisition for a larger company with excess capital.
It does suggest that ecomically rational valuations for P&C insurance companies are quite a bit higher than where they are trading today. Before the GFC, such companies often traded at a P/B of 1.2 to 1.4, while afterward they have traded at 1.0 or less. Many of them have excess capital, and trade at P/E's of less than 10, vs. historical averages in the 12 to 15 area.
Insurance companies, as a group, are still undervalued based on price to book. Perhaps the shock of a 90% premium will get investors looking more closely at this industry.