Notes for the readers
Chubb Limited is the world’s largest publicly traded property and casualty insurer. In 2016, ACE Limited (ACE) acquired Chubb for $29.5 billion in cash and stock. ACE took on Chubb's name as its own.
As stated by the company in the press release announcing the acquisition of Chubb, it was expected that the transaction would be immediately accretive to earnings per share and book value, and by year three, the transaction would be accretive to EPS on a double-digit basis and would be accretive to RoE. After almost one year (Chubb was acquired in January 2016), the newly merged company reported excellent FY 2016 results, with a better progress on merger’s accretive impacts than expected.
In 2017, Chubb continued to base its operating strategy on a strong underwriting performance. In July 2017, Chubb reported net income for the second quarter of 1,305 million, or $2.77 per diluted share or a 79.9% increase compared to the same quarter last year. On a year-to-date basis, the net income increased by 105.8% to $2,398 million. The quarterly dividend has been increased by $0.02 per share, and the company continued to repurchase its own shares to remove the dilutive effect following the merger (as a reminder, new shares have been issued to acquire Chubb).
As before the merger, the P&C insurer continued to outperform its peers operationally speaking and reward as much as possible its shareholders. Drawing on its underwriting know-how, this dividend-oriented stock has delivered strong results over the years. Last but not least, the company seems to be fairly valued at the current moment if the earnings would remain at the same level.
Regarding the current valuation environment, it is so rare that it deserves mention.
No Growth In The Earned Premiums…
In spite of a 4.8% increase in the gross written premiums on a year-to-date basis, the reported earned premiums were flat to $14,009 million. The growth in the North American commercial business offset the drop in the overseas general insurance segment. The United States represented on a year-to-date basis the largest part of the revenues, with 63% of the premiums written in the U.S.
Regarding the premium breakdown by product, we consider that Chubb’s portfolio is well diversified, mainly focused on the P&C products, as Chubb is a global market player in the non-life insurance market, with leading position in core markets (e.g., the crop insurance in the U.S.).
Despite the observed flat trend, Q2 2017 operating results were excellent, proving again that the increase at any cost in the turnover is not the panacea for a non-life insurer.
… But An Improved Underwriting Performance
A P&C company does not make money by writing more and more unprofitable policies. It is profit-making by reducing the administrative costs, the acquisition costs and the claims amount as far as possible. The underwriting process and the pricing power are the keys to the profitability of a non-life insurance company. Even it involves in a shitty business (e.g., large claim environment, moral hazard, bad risk profiles of the policyholders), it can make money; it should have a reliable claims history, skilled underwriters, and an efficient pricing. Chubb is present in traditional markets – for example, personal homeowner products – and particular businesses, as crop insurance products or kidnap and ransom coverages. Furthermore, Chubb’s portfolio is well-diversified to absorb smoothly adverse effects of a poor underwriting performance in one line of business. As management likes to state, Chubb is an underwriting company, which has a passion for the art and the science of underwriting.
With a five-year average combined ratio of 89.0%, the company (or the companies before the merger) was (were) always focused on monitoring risk with discipline.
The company outperformed the averages of North American and global peers over the last five years.
With an 87.8% year-to-date combined ratio, the underwriting performance of the first half of 2017 was excellent. Again, the company proved to everyone that the underwriting process was at the heart of its strategy.
The P&C underwriting income increased by $199 million in Q2 to reach to $1,591 million on a year-to-date basis.
The underwriting performance benefited from the synergies of the merger, with a more diversified and resilient portfolio.
At the segment level, every segment was profitable in Q2 2017. With a year-to-date combined ratio of 85.0%, the North American commercial business represented 42% of Chubb’s total underwriting income. The combined ratio of the North American personal segment improved significantly to 86.9%, thanks to an important reduction of the policy acquisition costs and the administrative expenses.
On a year-to-date basis, the North American agricultural insurance segment was relatively the most profitable business of the company’s segments, with a combined ratio of 67.7%, positively impacted by favorable prior reserve development. Only the profitability of the Overseas General Insurance segment deteriorated, with a 0.1 percentage point worsening.
Except for life insurance segment, the income of every segment increased from Q1 2017 to Q2 2017, mainly driven by the improvement of the underwriting performance and the higher investment income.
On a year-to-date basis, the segment income increased by $110 million to $3,095 million, mainly driven by the revenue growth of all North American segments.
Regarding the turnover growth expectation and the underwriting discipline, we could estimate that the operating income for P&C would be around $3,202 million before taxes. The hurricane Harvey could affect the P&C underwriting performance of the company, in spite of the reinsurance schemes set up by Chubb. Even if it cost three percentage points of loss ratio (which is very huge, regarding Chubb’s reinsurance schemes), the P&C operating income before taxes would be around $2.4 billion. Furthermore, the impact of the hurricane Harvey should be partially offset by the expected integration-related savings.
Depending on the investment income level, Harvey’s impact and the improvement or not of the life insurance underwriting income, we could expect an FY 2017 diluted EPS between $10 and $10.5.
Increase in the Quarterly Dividend and On-Going Share Repurchase
As many listed insurers, Chubb rewards its shareholders as much as it can. In Q2 2017, the dividend per share amount was increased by $0.02 compared to the prior quarter. Regarding the dividend history of the company, we could expect a 2017 annualized dividend of $2.82, or a 2% forward dividend yield. Furthermore, we could expect a gradual increase in the dividend (at least 3% per year) coupled with an active share buyback program.
Regarding the number of outstanding shares, the amount was flat compared to the prior year period. The number of outstanding shares amounted to 465 million while the diluted effects could increase the number of shares by 4 million. However, two points should be mentioned: with Chubb’s acquisition, 137 million of new shares have been issued in 2016. Furthermore, the Board authorized, in November 2016, a share repurchase program of $1.0 billion of Chubb's Common Shares through December 31, 2017.
As share repurchases totaled $335 million at the end of Q2 2017, we could expect the management to complete the share repurchase program and redistribute to Chubb’s shareholders the remaining $665 million through the share buyback program. At the current price, the company could repurchase around 4.7 million of common shares. Depending Chubb’s stock price evolution, we could expect the company to repurchase at least 4 million of its shares.
Overvalued or not?
Chubb usually takes the following companies as peers to show its outperformance regarding underwriting results: AIG (AIG), CNA Financial Corporation (CNA), Hartford Financial Services Group Inc. (HIG), Travelers Inc. (TRV) and XL Group (XL) for the North-American insurers. Regarding the valuation, we decided to take the following companies: all the companies as mentioned earlier, except AIG and Allstate (ALL) and Progressive (PGR). Furthermore, we used two approaches:
1. Historical multiples based on the P/E and P/B historical ratios of Chubb.
2. Valuation multiples based on a peer comparison
Based on a forward P/E and P/B ratios of 14.22 and 1.27, the next chart shows that Chubb is fairly valued regarding its historical averages or its peers.
Chubb delivered strong results in Q2, proving the disciplined underwriting culture forged over the years was at the heart of the company’s strategy. Other positive synergies related to the merger between ACE and the “old” Chubb could be still generated, boosting the net income accordingly. Last but not least, Chubb, with a 2% forward yield, is one of the rarest dividend-oriented insurance stocks which seem not to be currently overvalued.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.