Travelers: Strong Underwriting Performance, Fixed Income Returns Overcome Weak Private Equity Returns

About: The Travelers Companies, Inc. (TRV)
by: Power Hedge

Travelers beat analysts' expectations on both the top and bottom line.

The company boasted strong retention, higher premium renewals, and higher amounts of new business than a year ago.

The company saw its investment revenue decline YOY, due to poor returns from its private equity investments.

Book value per share improved during the quarter, which was a nice change from the declines that we saw in the latter half of last year.

The company remains a bastion of stability for any investor's portfolio.

On Thursday, April 18, 2019, property and casualty insurance giant The Travelers Companies., Inc. (TRV) announced its first quarter 2019 earnings results. At first glance, these results appeared to be quite solid as the company beat the expectations of its analysts on both the top and bottom lines. With that said though, it did actually miss in terms of total revenues as the usual metric that makes up the headline numbers for insurance companies is net written premiums and not total revenues. I have long posited that Travelers is one of the best companies in the insurance industry as it is quite conservatively managed and has long presented itself as something of a bastion of stability. We certainly see that reflected in these results. Thus, they provide a lot for investors to be pleased about.

As my long-time readers are no doubt well aware, it is my usual practice to share the highlights from a company's earnings report before delving into an analysis of its results. This is because these highlights provide a background for the remainder of the article as well as serve as a framework for the resultant analysis. Therefore, here are the highlights from Travelers' first quarter 2019 earnings results:

  • Travelers reported net written premiums of $7.057 billion in the first quarter of 2019. This represents a 3.41% increase over the $6.824 billion that the company reported in the first quarter of last year.
  • The company reported a very nice combined ratio of 93.7% in the most recent quarter. This was quite a bit better than the 95.5% that the company had in the year-ago quarter.
  • Travelers had total catastrophe losses of $193 million during the quarter. In the same quarter of last year, the company had catastrophe losses of $354 million, so this was quite nice to see.
  • The company bought back $421 million worth of its own stock during the quarter.
  • Travelers reported a net income of $796 million in the first quarter of 2019. This represents a 18.98% increase over the $669 million that it reported during the first quarter of 2018.

It seems likely that the first thing that anyone reviewing these highlights is likely to notice is that Travelers saw fairly strong growth (for an insurance company) in terms of net written premiums. This growth was driven primarily by growth in the company's business insurance unit, which might be expected as Travelers is primarily a business insurer. This unit was responsible for $4.163 billion of the company's $7.057 billion total, or approximately 59%. This figure was also $169 million higher than what the business unit reported in the equivalent quarter of last year. The company credits this partly to favorable renewals. In other words, when the company's customers went to renew their policies, Travelers was able to successfully increase the rate that the customer pays for the policy without the customer leaving for another insurer. This helps to reinforce my earlier statement that the company is generally considered to be a bastion of stability in the industry, which is something that policyholders usually like to see from their insurer. This perception is reinforced by the fact that the company issued more new policies in the first quarter of this year than in the prior year quarter despite the higher prices (which also had a positive effect on net written premiums).

One of the most important measures to use when judging the performance of an insurance company is the combined ratio. This is the percentage of the total premiums collected that were used to pay out claims to policyholders. Therefore, we can use this to determine if the company is pricing its products appropriately in order to generate an underwriting profit. It also tells us whether or not the company is being forced to use returns from its reserves to cover the claims that it is paying out. As mentioned in the highlights, Travelers is performing quite well here as it reported a combined ratio of 93.7% in the first quarter, down from 95.5% last year (lower numbers are better). This allowed the company to report an underwriting gain of $395 million in the quarter, a significant increase over the $258 million that it had last year. This results in more money being added to the company's investment portfolio, which is always nice to see.

One of the most disappointing things that we see in these results is that the company's investment income went down year over year. In fact, at $496 million, it was the lowest that the company had since 2017:

Source: Travelers

As most who are very familiar with the company know, Travelers' investment portfolio is mostly bonds, particularly municipal bonds. Interest rates went up last year, so we would think that this would have a positive effect on the income received from a bond portfolio since any new bonds purchased would have a higher interest rate. Actually, that was the case as the $461 million that Travelers received from its bond portfolio was 6.96% higher than the $431 million that this portfolio generated last year:

Source: Travelers

The weakness here thus comes from the portion of the company's portfolio that is invested in things other than fixed income securities. In fact, this portion generated only $43 million in income for the company during the period, less than half of the $90 million that it generated in the year-ago quarter:

Source: Travelers

Travelers specifically blames lower private equity returns than what it saw in the same quarter of last year. Those that follow the private equity industry at all are likely aware that large institutional investors such as insurance companies and pensions are some of the largest investors in private equity vehicles, so it does make some sense that Travelers would have some money invested here. As with any other asset class, the returns from private equity investments tend to fluctuate, and we can see here what happens when the sector has a bad quarter. Overall, though, there is no reason for us to worry here as Travelers' underwriting profit and improved returns from its fixed income portfolio more than overcome the weakness from its private equity investments.

Over much of last year, particularly the second half of the year, I was quite vocal about the fact that Travelers' book value was steadily declining. The reason for this was the rising interest rate environment, which caused the market price of all the bonds in the company's portfolio to decline in value. While this is not really a big deal if the company holds the bonds to maturity (as it will receive the entire principal back), it still was not particularly pleasant to see. Thus, it is a good thing that Travelers managed to reverse that trend during the first quarter. At the close of the quarter, Travelers reported that it now has a book value per share of $92.94, a 7% increase over what it had at the end of the fourth quarter. The company states that the value of its bonds went up due to somewhat lower market interest rates during the quarter, although it also seems likely that the underwriting profit and share buyback contributed to the increase.

In conclusion, the first quarter of 2019 was a very good one for Travelers. The company managed to grow its net written premiums as its reputation as a financially strong insurer shines through. We also saw the company's revenue from its bond portfolio grow due to the Federal Reserve's interest rate hikes, although its private equity investments delivered disappointing performance. The company also improved its book value, which was a nice change from the declines that we saw in the second half of last year. Overall, Travelers continues to show us that it is one of the most solid companies in the insurance space and should prove to be a bastion of stability for our portfolio.

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.