Chubb (NYSE:CB), like many of its Property and Casualty Insurance competitors, is trading at very low multiples - a P/E of 7.1 at today's price in the area of 47. While industry fundamentals are declining, I think much of the price reduction is part of the over-reaction to the credit crisis and a distaste for financials of any type. CB has increased their tangible book value per share at a rate of 10% a year for the past 10 years - a remarkable record of consistent results. With a secure dividend of 1.32, yielding 2.81% at today's price, and with the company buying back its shares at today's discounted prices, it makes good sense to accumulate a position and wait for price appreciation.
CB just reported 2Q 2008 earnings, a 27% decrease to 1,27, caused primarily by catastrophes which were well in excess of normal (see conference call transcript). Other industry participants have had similar catastrophe results: it's weather related. In addition, they had a large surety loss on a contractor that was unable to complete a job at the contract price. I reviewed the financials and listened to the conference call. Market reaction has been negative. CB operates in three segments- Personal Insurance, Commercial Insurance, and Specialty Insurance.
In Personal Lines, CB has concentrated on meeting the insurance needs of a wealthier clientèle. This is something of a specialty and has been profitable for them. The combined ratio for the quarter was 81.9%, an excellent result. There is some discussion that higher gas prices will result in fewer miles driven and accordingly a decrease in the frequency of claims. Probably the effect is smaller with the high end clientèle. In any event, the business is profitable.
In Commercial Lines, CB targets the middle market. That keeps them out of the large account arena where demands for concessions in price and terms can be intense under the soft market conditions that prevail today. They have been writing more business than they lose (1.1 to 1) and have been disciplined about price, although they are seeing about a 6% price decrease. That has been reflected in an increase in combined ratio. The combined ratio was 93.7%, including 9.2% of catastrophes. Overall, an impressive result in a soft market.
Specialty Insurance includes Professional Liability and Surety. Professional premiums were down 4% with a combined ratio of 84%. Surety premiums were down 10% and the combined ratio was 1208.4%, caused by one large loss. Surety is normally very profitable, with the occasional large loss which can lead to a bad quarter, as happened here.
Listening to the conference call, a lot of the analysts were looking for the credit crisis to spill over into Directors & Officers Liability (D&O) or Errors and Omissions (E&O). There was also the concern that Surety would be affected, since it is a form of Financial Guarantee - that contractors will complete their jobs. Credit problems in contractors could lead to loss problems for Chubb. Management addressed these concerns as follows: for D&O and E&O, to prove securities fraud, it is necessary to prove "scienter," or intent to deceive. The Supreme Court recently raised the bar on this issue, and so far the lower courts are doing a good job enforcing the new standard. This is a "long-tail" line - it takes a long time for losses to come in and be settled. CB makes a generous Incurred But Not Reported [IBNR] provision, so they are prepared. On Surety, CB is underwriting in the context of the current economic difficulties. They are skillful and selective underwriters and confident of their book of business. Personally, when I was in the business CB was always very well regarded for their underwriting skill and discipline and I tend to believe management has a handle on this situation. A few years ago the analysts were on the subject of possible claims from Employee Stock Options fraud, which management said they had a handle on, and nothing too much came of it.
Analysts were also concerned about where in the price cycle the industry is, how much further commercial lines prices will decline before they start back up. Management is of the opinion that industry combined ratios will get to triple digits before theirs do, As a practical matter, Professional Liability is not an easy line of business, if some other companies try to buy their way into it they will get in trouble soon enough and go away. In any event, insurance is a competitive business and Chubb is a strong and disciplined competitor.
Finally, some thoughts on Investment income. Chubb invests mostly in municipal bonds, a prudent course for a company that writes some fairly high risk insurance. The thinking here would be to avoid a nasty combination of operating and investment losses. They have avoided most of the MBS type problems others have experienced.
In spite of the higher than normal catastrophe claims, management reaffirmed their full year guidance. I think Chubb is a good long term investment. Working with 5 year average EPS and tangible book value ratios, I get a target price of 60. From 1998 to 2002 Chubb commanded higher multiples than it has lately: if multiples were to go back to what they were then a target would be more like 85.
Disclosure: Author holds a long position in CB