6 Undervalued Insurance Stocks for Your Watchlist

by: Hedgephone

Many insurance stocks have not given investors much to be happy about since the financial crisis, as many of the more speculative business models out there have outperformed blue chip insurance companies with the onslaught of stimulus measures in the economy. One reason that insurance companies may have underperformed is the increase in inflation expectations since the QE programs began digitally creating more money in bank reserves at the Federal Reserve.

While inflation is certainly a risk with insurance firms because customers pay up front fees for future liabilities which could rise with a lower dollar, many of the stocks in the industry look downright cheap. If hyperinflation doesn't set in, these names make a ton of sense. If hyperinflation is a big risk ahead, investors in these names could buy silver in an amount that will hedge their currency risks. Personally, I think we are headed for a continued stagflationary environment but I think these names should do well given their strong management teams and good core business moat when combined with cheap valuations.

However, the biggest risk for insurance investors over the past year has been large catastrophe losses, and the reinsurance sector has been particularly hard hit. Reinsurance rates were pretty low going into Japan and the New Zealand earthquake. Making matters worse for cat. loss insurers was the huge tornado damage in Alabama and Missouri and the flooding in the Midwest, as well as the fire damage in the Southwest. Allstate (NYSE:ALL), for example, has reportedly lost over 2 billion from the Alabama and Missouri disasters alone, while Travelers (NYSE:TRV) is reporting that after tax losses for April and May will be over 1 billion. In other words, it has been a tough time to invest in the insurance industry, but cheap valuations could mean good values in the space for enterprising investors.

Here is a quick review of 6 insurance companies and their valuations:

Berkshire Hathaway (NYSE:BRK.A) -- Though Berkshire Hathaway is not primarily a reinsurance business, it was negatively affected by losses in Japan last quarter. Buffett is also a bull on the stock market, which has been choppy and tough to navigate so far this year. With that said, his investments in Coke (NYSE:KO) may not have moved up, but his short options positions on the S&P are likely making money now, and once the slew of natural and man made disasters subsides, Berkshire stock will likely get a lift on higher earnings. BRK is trading for a 30% or so premium to book value, which in my view makes this name a bargain at current levels.

Renaissance Re Holdings (NYSE:RNR) -- Renaissance Re is a cheap reinsurance name that is trading below book value and for just 8.7X forward earnings. Unlike many of its peers, RNR has delivered strong earnings over the past year with a PE of around 13X. Renaissance appears to be well positioned and reinsurance rates have likely gone up after oil spills, earthquakes, floods, tornadoes, and other seemingly Biblical events have punished the company's bottom line. While RNR is pretty cheap here and management is buying back a good deal of stock, investors should note the relatively low ROE and also the higher risk involved with the overall reinsurance industry. One thing we like at RNR is its low debt to equity ratio.

Greenlight Capital Reinsurance (NASDAQ:GLRE) -- Greenlight Capital Reinsurance is an interesting way to invest alongside investment legend and Mets owner David Einhorn. GLRE is a cheap stock currently at 6.88X forward estimates, but Einhorn is reportedly down 5% YTD and most of GLRE's earnings come from Einhorn's investment results. Overall, I believe GLRE is a good investment anywhere close to book value. Even though the investor has struggled a bit lately, I believe in his long term bottoms up, fundamental analysis approach to investing. Because investors can buy GLRE as a way to invest with Einhorn, I like this name-- even though the price to book value of 1.3X seems a little high at first glance.

Aetna (NYSE:AET) -- Aetna is one of the largest health insurance companies in the country. Ask a healthcare professional and they will tell you that Aetna has a virtual monopoly over the Medicare business and that the company will only grow in the future. AET trades for just 10X trailing earnings and 9.47X forward earnings. While price to book is a little high for us, we like that Aetna is in the red hot medical sector because more and more people will be purchasing health plans from this company in the future, regardless of whether ObamaCare is implemented or not. We also think that ObamaCare will directly help, not hurt, this business-- because people will essentially be forced to purchase plans from the company. Small businesses will be more or less forced to do business with Aetna if our understanding of the bill is correct.

Kansas City Life (NASDAQ:KCLI) -- Kansas City Life is a company that is a classic deep value stock where management should consider a large share repurchase, or even a sale of the company to reward its current shareholders and unlock value. Trading for just half of book value, this Kansas City based insurance firm is too cheap to ignore. Life insurance is also not as vulnerable to inflation concerns because policies are not affected the way cat losses are with higher prices -- most life insurance premiums provide a fixed payout when someone dies. Like most life insurance companies, KCLI invests in bonds, so the business earns money on the float and has to pay out reserves when customers bite the dust. Because the death benefits are not increased with inflation, KCLI could actually benefit modestly from inflation if the company diversified its investment portfolio into things like equities (although I am not too bullish on index funds here), select commodities, foreign currencies, and hedge funds. Because this company has a large percentage of insider ownership, this stock could tread water for some time, bit over the long haul I think the stock is a bargain and should reward patient investors.

Humana (NYSE:HUM) -- Humana, like Aetna, stands to benefit from an overall healthcare spending market that should rise some 10% per year over the next decade. Because boomers are getting older, Humana's positioning in the health insurance industry should place the company in a strong position for future growth. Luckily for investors, this future growth comes at a reasonable price tag -- even after the stock has almost doubled over the past nine months. HUM trades for just 10.88X forward earnings and just 2.8X EV/EBITDA. Return on equity of 17% and earnings growth of 21% are two additional reasons that HUM is a cheap stock at current prices when they are viewed along with the PE and price to cash flow here. Insiders have been selling some stock here, however I think HUM has pretty strong tailwinds driving in its core businesses.

Disclosure: I am long BRK.B.

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