Insurance Pool (Property & Casualty)
“An ounce of prevention is worth more than a pound of cure” – Benjamin Franklin
The founding father of insurance in America is Benjamin Franklin. He started the Philadelphia Contributionship insurance company in Philadelphia. The goal, provide for replacement costs of a home destroyed by fire in Philadelphia. The idea of insurance spread; and over time, more than just homes are covered by insurance. Today, insurance addresses multiple risks that exist. From life to health and even title insurance for real estate are just a few of the many risk absorption tools to prevent catastrophic financial loss.
This section of Value Investment Pools covers property and casualty loss insurance companies. Common risks include auto, home, workers compensation, business general liability, business property, and title insurance. It specifically excludes health, retirement, and most common forms of life insurance. As stated many times within the value investing section of this website, it is very difficult to find two companies that sell the exact same set of products or provide the same service for comparative purposes. As such, a couple of the members within this pool do sell life insurance products or retirement types of products as an item on their insurance menu. However, their primary forms of products are indeed, property and casualty forms of insurance.
Insurance is a $1.3 Trillion business in the form of premiums excluding health insurance. Half of this business is property and casualty insurance at $650 Billion per year. This site’s six members within this pool comprise over 16% of all property and casualty business. There are currently 2,500 property and casualty insurance companies in the United States. Most of the businesses operate as mutual insurance companies; the most notable is State Farm with over 9% of all premiums earned. Mutual and private property and casualty insurance underwriters are not publicly traded. There are about 15 property and casualty insurance companies in the top 2,000 publicly traded companies in the United States. This pool of six earns over 60% of all the property and casualty premiums earned by publicly traded insurance companies; thus, it is a highly selective pool representing this type of insurance and reflects this industry well.
Insurance Pool (Property and Casualty) – Financial Matrix
Property and casualty (P&C) insurance companies have a highly complex financial matrix. Novice investors would think of them as merely a company that earns premiums and pays out claims. The difference is effectively margin which then covers overhead and generates a profit. The truth is not this simple. In reality, P&C companies utilize a very complex revenue generating system and the most sophisticated balance sheet presentation to explain their profitability and long-term viability.
In general, property and casualty insurance companies are really two business operations combined. The first is the traditional premiums earned against losses paid out. From the difference here, the company’s goal is to cover overhead including commissions paid to agents along with other operational costs. The end result is some profit to add to the company’s reserves against future catastrophic events. The second arm of operations is more in line with an investment company. Unlike most balance sheets, the balance sheet of a P&C company is heavily weighted with current assets in the form of investments. The bulk of these investments are fixed income generating securities like bonds. The balance is typically equity investments such as stock or strong positions with limited liability companies. The investment portfolio makes up more than 70% of all assets found on the balance sheet. Liabilities are also heavily weighted with current liabilities and are mostly driven by the expected future claims to be made against premiums earned. In effect, a P&C company’s number one liability is the value of future expected losses.
What really complicates property and casualty insurance companies are the different tools they use to minimize risk. These various tools include:
- Separate Accounts
- Contract Holder Accounts
- Managed Investments
All of these tools and their impact on intrinsic value, market value and the buy/sell prices are explained in detail in this section of investment fund pools. For the purpose of introducing property and casualty insurance, suffice it to say that this industry has the most complicated set of financial statements. It is important for a value investor interested in buying and selling publicly traded property and casualty insurance companies to understand all the terminology, financial interactions and impact all the different tools insurance companies use to generate a profit and add value for their shareholders.
There are several advantages to having this type of pool within your investment portfolio.
First, insurance companies have very low volatility related to their market share price change. As an example, over the last six years, Travelers Insurance, a DOW company, has seen its stock price vary from a low of $90 to a high of $163. During this six-year time period, there have only been two times that the stock price dropped more than 18% from a recent high point. Thus, if a value investor can purchase this stock with a margin of safety of around 11% from its intrinsic value, the downside risk is pretty much eliminated. There would have to be a long period of time with a batch of continuous catastrophic losses nationwide to cause the stock price to slip further lower.
Secondly, determining intrinsic value is straight forward. Intrinsic value is heavily weighted by the balance sheet’s quality of investments. With property and casualty insurance companies, the intrinsic value formula switches from income statement or cash flow based discounted methods to the net equity position on the balance sheet multiplied by a factor of .9 to 1.5 depending on the quality of investments and ability to generate profit from its portfolio of policies and investments.
Finally, all of them pay out at least one-third of their annual earnings in the form of dividends. Dividend yields are strong across the board with the lowest one within this group of six at just over 2%. The best within the group is producing an unheard-of dividend yield of 6.8%.
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